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The 16 countries that comprise the European Union agreed in 1997 to be governed relative to national spending and debt by a document called the Stability and Growth Pact. EU member nations signed the pact primarily to guard against inflation in their individual currencies and in the Euro. The Stability and Growth Pact was modified in 2005 to give a little more flexibility to individual nations in budgeting for economic cycles of longer than a year.
Under terms of the pact, EU nations agreed that the budget deficit, including all budgets national and local, will not top 3 percent of the Gross Domestic Product of the nation. Further, the Stability and Growth Pact nations agreed that each nation’s debt would not exceed 60 percent of Growth Domestic Product. The term Gross Domestic Product refers to a value of all goods and services produced by a nation over a give time period, usually one year.
Not considered a treaty, the Stability and Growth Pact is an agreement as opposed to the Treaty of Maastricht, which was the legal document that created the European Union. Two articles in that treaty — the Treaty of Rome or the Treaty Establishing the European Economic Community — establish the legal basis for the provisions of the Stability and Growth Pact. In addition to the debt and spending limits, the pact allows for warnings and then sanctions if the limits are not met.
The Stability and Growth Pact has been criticized for being both too firm and too rigid. Those who claim it is too firm point to the need for governments to have latitude as to the use of debt and spending to address the impact of economic downturns, which can last far longer than a year. Others have claimed the pact to be to soft in that the use of creative accounting can mask non-compliance and that the sanctions are too rarely used and too lenient to be effective.
In 2005, officials amended the pact, largely at the insistent of Germany and France. The pact had first been proposed in the 1990s by Germany. Under the reform, the 3 percent and 60 percent deficit and debt levels stayed in place, but prior to sanctions being assessed, the EU finance ministers could take into account the severity of an economic downturn and could calculate compliance based on a budget adjusted over the life of the current economic cycle.