Fiscal discipline and flexibility in EMU: The implementation of the stability and growth pact

Fiscal discipline to safeguard the credibility of the single monetary authority and fiscal flexibility to respond to country-specific shocks are two core principles governing budgetary policy in EMU. The Stability and Growth Pact aims at ensuring the first objective. To comply with the requirements of the pact, EU members need to achieve a 'close to balance or surplus' position and change their budgetary behaviour in periods of cyclical upturns by refraining from spending the 'growth dividend'. Past experience shows that fiscal laxity does not buy more effective stabilization. Once EMU countries have achieved their medium-term target, their automatic stabilizers will be able to operate fully, thus helping in smoothing out cyclical fluctuations. The main potential problems in the implementation of the pact may arise in the early years of EMU, during the transition to a balanced budget in the event of a slow-down in economic activity.