The economic debate in this election year has centered on the costs of proposed policies. Politicians have been trying to put the cart before the horse, as they make plans to spend money before being certain that the money will be available.
The debate on this front has been particularly active in Europe, where rules on national budgets underpin the monetary union. Tensions over how those rules should be applied have simmered frequently since they were first adopted, but they may be on the verge of boiling over.
The first Stability and Growth Pact (SGP) was adopted in 1997. It established caps on annual government deficits and aggregate public debt for countries using the euro. The Pact has been updated and amended several times, most recently late last year. We expressed concern about the most recent edition in this January commentary.
The reformed rulebook retains the two goals of maintaining public debt below 60% of gross domestic product (GDP) and deficits below 3% of GDP. However, it allows a slow but steady pace of deficit and debt reduction over four to seven years, with the longer option available if a country undertakes reforms and investments that are in line with the bloc’s strategic priorities.
The SGP calls for the European Commission (EC) to enforce the standard. The vehicle through which this is achieved is called an Excessive Deficit Procedure (EDP), which initiates a timetable for countries to get their fiscal positions back within guidelines.
The EC can also levy penalties if a country fails to take corrective action. This step has never been taken, given the potential for adverse political and economic reactions.
It didn’t take long for the new pact to be put to the test. The EC recently took the first step towards placing seven countries into an EDP. Among the seven was France, which drew a lot of attention because of the sheer size of its economy, deficit and debt.
The EC decided to exempt Spain from the disciplinary step, despite the country exceeding the fiscal limits. Deficits and debt there are to follow a downward trajectory, as per a recent European Commission forecast, which allowed some lenience.
FRANCE WILL REQUIRE SIGNIFICANT BUDGET DISCIPLINE TO COMPLY WITH EC RULES.
For France, the announcement couldn’t come at a worse time. President Emmanuel Macron’s gamble to call snap elections has backfired, pushing the country into a period of uncertainty. The deeply divided government that will soon be seated has sparked renewed concern about the sustainability of French public finances.
Public debt in France is projected by the EC to rise from 110% of GDP in 2023 to almost 114% of GDP next year. In May, global ratings agency S&P downgraded the country’s credit score for the first time since 2013, amid the deteriorating budget position.
It didn’t take long for the new pact to be put to the test. The EC recently took the first step towards placing seven countries into an EDP. Among the seven was France, which drew a lot of attention because of the sheer size of its economy, deficit and debt.
The EC decided to exempt Spain from the disciplinary step, despite the country exceeding the fiscal limits. Deficits and debt there are to follow a downward trajectory, as per a recent European Commission forecast, which allowed some lenience.
FRANCE WILL REQUIRE SIGNIFICANT BUDGET DISCIPLINE TO COMPLY WITH EC RULES.
For France, the announcement couldn’t come at a worse time. President Emmanuel Macron’s gamble to call snap elections has backfired, pushing the country into a period of uncertainty. The deeply divided government that will soon be seated has sparked renewed concern about the sustainability of French public finances.
Public debt in France is projected by the EC to rise from 110% of GDP in 2023 to almost 114% of GDP next year. In May, global ratings agency S&P downgraded the country’s credit score for the first time since 2013, amid the deteriorating budget position.
Some would argue that a slower pace of deficit reduction will reduce the drag on growth in France, but it is also worth stressing that an expansionary fiscal policy will raise concerns of sustainability of public debt. This would cause financial conditions to tighten, thereby weighing on growth. Already, the spread of French bond yields to German bond yields has widened considerably.
The exact size of required fiscal correction for France will be known by the fall when the government prepares next year’s budgets. A deficit reduction of at least 0.5% of GDP is mandated by the new European fiscal policy.

