Stability and Growth Pact (SGP): Meaning, History, and Criticism

What Is the Stability and Growth Pact (SGP)?

The Stability and Growth Pact (SGP) is a binding diplomatic agreement among European Union (EU) member states. Economic policies and activities are coordinated cohesively to safeguard the stability of the economic and monetary union.

How the Stability and Growth Pact (SGP) Works

The SGP aims to ensure that countries in the EU do not spend beyond their means. To achieve this goal, a set of fiscal rules are enforced to limit budget deficits and debt relative to gross domestic product (GDP).

The European Commission and the Council of Ministers issue an annual recommendation on policy measures and survey member states in order to keep each nation compliant with budget regulations. According to the agreement, countries that break the rules for three consecutive years are fined a maximum of 0.5% of their GDP.

SGP Requirements

The SGP sets two hard limits on EU member states: a state's budget deficit cannot exceed 3% of GDP and national debt cannot surpass 60% of GDP. In cases where a national debt exceeds 60% of the member state’s GDP, it must be declining at a reasonable pace to within acceptable limits to avoid incurring penalties.

To ensure that all EU member states are evaluated and scrutinized for compliance, each is required to submit an SGP compliance report to the European Commission and Council of Ministers. The report also informs the aforementioned entities of the expected economic development of the member state for the current and subsequent three years. These are called “stability programmes” for eurozone member states and “convergence programmes” for non-eurozone member states.

In 2005, the SGP was reformed, requiring economic reports to contain a “Medium-Term Budget Objective,” or MTO. This additional measure was introduced to enable member states to show the European Commission and Council of Ministers how they intend to bring their balance sheets within acceptable regulatory standards.

If a member state is outside of acceptable limits and deemed not to be doing enough to rectify the situation, the EU initiates a so-called “Excessive Deficit Procedure,” whereby the guilty party is issued a deadline to comply and a detailed economic blueprint to bring it back under acceptable limits.

History of the SGP

The SGP legislative foundation is the language of Articles 121 and 126 of the Treaty on the Functioning of the EU, which came into effect Jan. 1, 1958; however, the pact itself was only formalized via council resolution in July 1997 and fully came into effect Jan. 1, 1999. 

When the eurozone and euro currency were created, national governments remained in charge of their own fiscal policies, while the European Central Bank (ECB) took charge of managing interest rates and controlling inflation.

Having a monetary union but no fiscal union among member states created an incentive for governments to engage in excessive deficit spending on the expectation that more fiscally responsible states would inevitably face a dilemma between bailing out their free-spending partners or else risk destabilizing the currency.

Since all member governments face this incentive, this situation sets up a kind of prisoner's dilemma game, where all member governments have the incentive to defect by running high deficits to please domestic voters while risking the collapse of the common currency.

Anticipating the dangers of this moral hazard, Germany lobbied for the SGP rules to be introduced, worried that some nations would trigger high inflation by cutting taxes and spending lavishly.

Criticisms of the SGP

The SGP is often criticized for its strict fiscal rules. Some complain that it violates national sovereignty and serves to punish the poorest member states.

The agreement has also come under attack for its lack of compliance and perceived favoritism toward certain nations. The Council of Ministers reportedly never considered levying penalties against France or Germany, even though both breached the 3% deficit limit in 2003.

In contrast, other countries, such as Portugal and Greece, have been threatened with big fines in the past.

Critics say France and Germany are protected because of their hefty and disproportionate representation on the Council of Ministers. The SGP was a major talking point during the political campaigning leading up to the British referendum on Brexit in 2016.

Relaxation of SGP Rules During COVID-19

In March 2020, the European Commission activated a general escape clause in the SGP, allowing member governments to exceed the normal deficit and debt limits due to the sudden economic shock caused by governments' reactions to the COVID-19 pandemic. In 2021, the Commission announced that these rules would remain suspended until the end of 2023.

The Bottom Line

The Stability and Growth Pact (SGP) was created to ensure economic stability within the European Union by ensuring that member countries do not overspend. In order to achieve this, the pact has enforceable rules, such as limits on budget deficits and debt-to-GDP ratios.