The SGP – Faulty by Design or Made Faulty by Politicians? An Assessment Based on a Simulation Model

Abstract

By joining the European Monetary Union (the "EMU"), member countries lost the ability to use monetary policy as a tool for macroeconomic regulation. The attention was then focused on regulation of fiscal policy and Stability and Growth Pact (the "SGP") was the instrument agreed upon. The states of the EMU have agreed to meet the 3% of GDP requirement for the maximum annual public budget deficit. Based on evolution of public debt in member countries, we can say that the SGP has failed as a tool for fiscal discipline. In this paper, we answer the question of whether the failure was due to the incorrect concept of the SGP or whether the development of the debt was affected more by arbitrary disrespect of the agreed rules. The two reasons mentioned above are interdependent. To separate them, we construct a dynamic model of EU countries' public debt. By using real data, we simulate the potential values of public debt in a situation where the SGP rules have been respected in recent years. Comparing the results for the potential debt given by simulation of the model with the current real values, we are able to quantify the impact of non-compliance for each country. The initial results indicate that there are both EU states where non-compliance led to a negligible increase in public debt -up to 7% of GDP -and other states where this factor caused the growth of public debt by more than 30% of GDP.