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European Commission

MEMO

Brussels, 10 April 2013

The EU's economic governance explained

The lessons learned from the recent economic, financial and sovereign debt crisis have led to successive reforms of the EU's rules, introducing, among other things, new surveillance systems for budgetary and economic policies and a new budgetary timeline.

The new rules (introduced through the Six Pack, the Two Pack and the Treaty on Stability, Coordination and Governance) are grounded in the European Semester, the EU's policy-making calendar. This integrated system ensures that there are clearer rules, better coordination of national policies throughout the year, regular follow-up and swifter sanctions for breaching the rules. This helps Member States to deliver on their budgetary and reform commitments while making the Economic and Monetary Union as a whole more robust.

The following are the essential features of the new system.

MORE RESPONSIBLE BUDGETING

The Stability and Growth Pact was established at the same time as the single currency in order to ensure sound public finances. However, the way it was enforced before the crisis did not prevent the emergence of serious fiscal imbalances in some Member States.

It has been reformed through the Six Pack (entry into force in December 2011) and the Two Pack (will enter into force in May 2013), which brought in important changes to the rules and to how the rules are enforced. Its rules are reinforced by the Treaty on Stability, Coordination and Governance (entry into force in January 2013 in the 25 signatory countries).

Better rules

  1. Headline deficit and debt limits: Limits of 3% of GDP for deficits and 60% of GDP for debt are set in the Stability and Growth Pact and enshrined in the Treaty. They remain valid.

  2. A stronger focus on debt: The new rules make the 60% of GDP debt limit operational, which was not the case before the Six Pack reform. The rule is broken if Member States with debts of above 60% of GDP do not reduce the excess by at least 5% a year on average over three years.

  3. A new expenditure benchmark: Under the new rules, public spending must not rise faster than medium-term potential GDP growth, unless it is matched by adequate revenues.

  4. The importance of the underlying budgetary position: The Stability and Growth Pact focuses more than before on improving public finances in structural terms, that is, taking into account the effects of an economic downturn or one-off measures on the deficit. The Pact differentiates between Member States, which set their own medium-term budgetary objectives, updated at least every three years, with the goal of improving their structural balance by at least 0.5% of GDP a year. Member states with high debts (over 60%) should do more. This provides for a safety margin against breaching the 3% headline limit.

  5. A fiscal pact for 25 member states: Under the Treaty on Stability, Coordination and Governance (TSCG), from January 2014 medium-term budgetary objectives must be enshrined in national law and there must be a limit of 0.5% of GDP on structural deficits (rising to 1% in exceptional circumstances). This is called the Fiscal Pact. The treaty also says that automatic correction mechanisms should be triggered if the structural deficit limit is breached, which would require Member States to set out in national law how and when they would rectify the breach over the course of future budgets.

  6. Flexibility during a crisis: By focusing on the underlying budgetary position over the medium term, the Stability and Growth Pact can be flexible during a crisis. If growth deteriorates unexpectedly, Member States with budget deficits over 3% of GDP may receive extra time to correct their deficits, as long as they have made the necessary structural effort. This was done in 2012 for Spain, Portugal and Greece.

Better enforcement of the rules

  1. Better prevention: Member States are judged on whether they meet their medium-term targets. Progress is assessed each April when Member States present their three-year budget plans, or Stability/Convergence Programmes (the former for euro area countries, the latter for the EU). These are published and examined by the Commission and the Council within, at most, three months. The Council can adopt an opinion or invite Member States to make adjustments to the programmes.

  2. Early warning: If there is a "significant deviation" from the medium-term targets, the Commission addresses a warning to the Member State, to be endorsed by the Council and which can be made public. The situation is then monitored throughout the year, and if it is not rectified, the Commission can propose an interest-bearing deposit of 0.2% of GDP (euro area only), which must be approved by the Council. This can be returned to the Member State if it corrects the deviation.

  3. Excessive Deficit Procedure (EDP): If Member States breach either the deficit or debt criteria, they are placed in an Excessive Deficit Procedure, where they are subject to extra monitoring and are set a deadline for correcting their deficit. Compliance with the terms is checked by the Commission throughout the year, but particularly in the spring and autumn, when the Commission publishes its economic forecasts.

  4. Swifter sanctions: For Member States in the Excessive Deficit Procedure, financial penalties kick in earlier and can be gradually stepped up. Failure to reduce the deficit can result in a fine of 0.2% of GDP. This is deemed approved by the Council unless a qualified majority of Member States overturns it (this is called Reverse Qualified Majority Voting). Fines can rise to a maximum of 0.5% if statistical fraud is detected and penalties can also include a suspension of Cohesion funding. In parallel, the 25 Member States that signed the TSCG can be fined 0.1% of GDP for failing to properly integrate the Fiscal Pact into national law.

  5. New voting system: Decisions on sanctions under the Excessive Deficit Procedure are taken by Reverse Qualified Majority Voting (RQMV), which means fines are deemed to be approved by the Council unless a qualified majority of Member States overturns them. This was not possible before the Six Pack entered into force. In addition, the 25 Member States that have signed the Treaty on Stability, Coordination and Governance have agreed to vote by Reverse QMV even earlier in the process, for example, when deciding whether to place a Member State in the Excessive Deficit Procedure.

STEPPED-UP SURVEILLANCE IN THE EURO AREA

The crisis has showed that difficulties in one euro area Member State can have important contagion effects in neighbouring countries. Therefore, extra surveillance is warranted to contain problems before they become systemic.

The Two Pack allows for surveillance to be gradually stepped up for euro area Member States with high deficits or debts, or for those facing difficulties with regard to their financial stability. The Two Pack comes into force on 30 May 2013.

  • Member States not in Excessive Deficit Procedure: surveillance extends to the three-year budget plans submitted by Member States each April and the draft budgets for the following year, submitted in October. If there are no concerns at EU level, then surveillance remains limited.

  • Member States in Excessive Deficit Procedure: are subject to extra surveillance. They must undertake not only fiscal consolidation but they must also sign "economic partnership programmes", which contain detailed structural reforms which they intend to put in place to improve competitiveness and boost growth. This idea was first outlined in the Treaty on Stability, Coordination and Governance and is now enshrined in EU law.

  • Member States experiencing financial difficulties: or those under precautionary assistance programmes from the European Stability Mechanism are put under "enhanced surveillance", which means they are subject to regular review missions by the Commission and must provide additional data on their financial sectors.

  • Financial assistance programmes: Member States whose difficulties could have "significant adverse effects" on the rest of the euro area can be asked to prepare full macroeconomic adjustment programmes. This decision is taken by the Council, acting by a qualified majority on a proposal from the Commission. These programmes are subject to quarterly review missions and strict conditions in exchange for any financial assistance.

  • Post-programme surveillance: Member States will undergo post-programme surveillance as long as 75% of any financial assistance drawn down remains outstanding.

MONITORING EXTENDED TO ECONOMIC POLICIES

Before the crisis, economic policy coordination was mostly voluntary. Member States submitted National Reform Programmes each year, setting out the economic reforms they intended to undertake the following year, but there was no binding process in place to monitor and correct the emergence of imbalances in national economies.

The European Semester and the Six Pack reforms introduced a system of monitoring for economic policies, mirroring the budgetary monitoring in place under the Stability and Growth Pact. This is called the Macroeconomic Imbalances Procedure.

  • Better prevention: All Member States continue to submit National Reform Programmes – this is now done every year in April. These are published by the Commission and examined to ensure that any planned reforms are in line with the EU's growth and jobs priorities, including the Europe 2020 strategy for long-term growth.

  • Early warning: Member States are screened for potential imbalances against a scoreboard of 11 indicators, which measures the evolution of their economies over time. Each November, the Commission publishes the results in the Alert Mechanism Report (see MEMO/12/912). The report identifies individual Member States that may be at risk of imbalances and for which it will undertake In-Depth Reviews.

  • In-depth reviews: The Commission undertakes an In-Depth Review of those Member States identified in the AMR that are potentially at risk of imbalances. The In-Depth Review is published in the spring and confirms or denies the existence of imbalances, and whether they are excessive or not. Member States subject to an In-Depth Review are requested to take the findings into account in their National Reform Programmes and their Stability and Convergence Programmes. The results feed into the policy advice the Commission gives to each Member State in its Country-Specific Recommendations at the end of May.

  • Excessive Imbalances Procedure: If the Commission concludes that excessive imbalances exist in a Member State, it recommends the Member State draw up a corrective action plan, including deadlines for new measures. This recommendation is adopted by the Council. The Commission monitors the Member State throughout the year to check whether the imbalances are being corrected.

  • Fines for euro area Member States: If the Commission concludes that a euro area Member State's Corrective Action Plan is unsatisfactory, it proposes that the Council levy a fine of 0.1% of GDP a year. Penalties can also be levied and stepped up if Member States fail to take corrective action based on the plan (starting with an interest-bearing deposit of 0.1% of GDP, which can be converted to a fine if there is repeated non-compliance). The sanctions are approved unless a majority of Member States overturn them.

COORDINATION THROUGHOUT THE YEAR: THE EUROPEAN SEMESTER

Before the crisis, budgetary and economic policy planning in the EU took place through different processes. Reports were issued separately and decisions were spread throughout the year. There was no clear, comprehensive view of the efforts made at national level, and no opportunity for Member States to discuss a collective strategy for the EU economy.

Coordination and guidance

The European Semester, introduced in 2010, ensures that Member States discuss their budgetary and economic plans with their EU partners at specific times throughout the year. This allows for the peer review of plans and enables the Commission to give policy guidance to Member States in good time, before decisions are finalised at national level. It also enables Member States to work towards the targets set in the Europe 2020 strategy, the EU's long-term growth strategy.

A clear timeline

The cycle starts in November each year with the Annual Growth Survey (general policy guidance) and culminates in the adoption of Country-Specific Recommendations (individual advice) by EU finance ministers in July (see table below). The new budgetary timeline introduced in the Two Pack completes the annual economic and fiscal policy cycle for the euro area.

  • November: The Commission’s Annual Growth Survey sets out overall economic priorities for the EU for the following year. The Alert Mechanism Report, published alongside it, identifies Member States that may be at risk of imbalances, and which require an In-Depth Review of their economies.

  • February: The European Parliament and the relevant Council formations (employment, economic and finance, and competitiveness) discuss the Annual Growth Survey. In February, the Commission also publishes its Winter Economic Forecast.

  • March: The European Council adopts economic priorities for the EU, based on the Annual Growth Survey.

  • April: Member States submit their Stability/Convergence Programmes and their National Reform Programmes, which should be in line with the Annual Growth Survey. These are due by 15 April for euro area countries, and by the end of April for the EU. Also in April, the Commission publishes the In-Depth Reviews and Eurostat verifies the previous year's fiscal data. This is important to check that Member States are meeting their Stability and Growth Pact targets.

  • May: The Commission proposes Country-Specific Recommendations, bespoke policy advice to the Member States based on EU priorities and on national budget and reform plans. Since they are country-specific, they can focus on the particular challenges of each Member State in an EU-wide context. In May, the Commission also publishes its Spring Forecast.

  • June: The European Council endorses the Country-Specific Recommendations, and EU ministers discuss them in the Council (employment, economic and finance, and competitiveness).

  • July: European finance ministers (in the Ecofin Council) adopt the Country-Specific Recommendations.

  • New budgetary timeline for the euro area: From 2013 onwards, euro area Member States must submit their draft budgets for the following year to the Commission by 15 October - before they are voted through in national parliaments. The budgets should be adopted by national parliaments by the end of December. If the Commission finds that a draft budget is out of line with a Member State's medium-term targets, it can ask for it to be redrafted.

A BLUEPRINT FOR THE FUTURE

The reforms undertaken over the last three years are unprecedented, but the crisis has demonstrated how much the interdependence of our economies has increased since the foundation of the Economic and Monetary Union. This also shows that we require more fundamental changes to the economic governance architecture to restore confidence in the achievements of the Single Market and the single currency.

The European Commission's ideas for the future are set out in the Blueprint on a Deep and Genuine Economic and Monetary Union, published on 28 November 2012 (see IP/12/1272). The Blueprint sets out how to build on the architecture we have, step-by-step, in the coming months and years.

The Commission has already developed its ideas on a framework for the ex-ante coordination of major structural reforms and on a convergence and competitiveness instrument to encourage and support Member States that are implementing difficult reforms (see IP/13/248). Further proposals will be made in the course of 2013.

For further information see:

http://ec.europa.eu/europe2020/europe-2020-in-a-nutshell/priorities/economic-governance/index_en.htm

MEMO/13/457 ‘Two-Pack’ enters into force, completing budgetary surveillance cycle and further improving economic governance for the euro area

MEMO/11/898 EU Economic governance "Six-Pack" enters into force

MEMO/11/14 European semester: a new architecture for the new EU Economic governance – Q&A

Contacts:

Olivier Bailly (+32 2 296 87 17)

Sarah Collins (+32 2 296 80 76)

Simon O'Connor (+32 2 296 73 59)

Vandna Kalia (+32 2 299 58 24)


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