Communication from the Commission to Council and the European Parliament - Strengthening the co-ordination of budgetary policies
Date: 2002-11-27
Institutions: European Commission
Subjects: Economic and Monetary Union, budget policy, coordination of EMU policies, stability pact

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 27.11.2002
COM (2002) 668 final

COMMUNICATION FROM THE COMMISSION TO COUNCIL AND THE
EUROPEAN PARLIAMENT

Strengthening the co-ordination of budgetary policies

1. 

Background

This Communication follows the conclusions of the 2002 Barcelona European Council on the
need to reinforce existing fiscal policy co-ordination mechanisms, and for the Commission to
“…  present  proposals  to  reinforce  economic  policy  co-ordination  in  time  for  the  Spring
European  Council.”  It  forms  part  of  a  more  general  strategy  to  strengthen  economic  policy
co-ordination,  including  the  recent  efforts  to  streamline  procedures  for  the  adoption  and
implementation of the Broad Economic Policy Guidelines and the Employment Guidelines. 1
It also draws upon the relevant proposals forwarded by the Commission to the Convention on
the Future of Europe.2

In  particular,  the  Communication  outlines  proposals  to  improve  the  implementation  of  the
Stability and Growth Pact (SGP), and develops the ideas presented by the Commission on 24
September  2002.3  In  addition  to  securing  the  core  budgetary  objectives  of  sound    and
sustainable public finances, the proposals aim at raising the contribution of public finances to
growth and employment in line with the Lisbon strategy.

2.

The SGP: an appropriate framework for the conduct of budgetary policies with
valid short and long-term objectives

Sound public finances are at the core of EMU. The emphasis on fiscal prudence derives from
the  awareness  that  economic  prosperity  and  the  viability  of  the  monetary  union  cannot  be
sustained  without  tackling  past  fiscal  policy  failures,  i.e.  a  trend  towards  increasing
government expenditure and taxation levels combined with high structural budget deficits and
government  debt  accumulation,  and  the  tendency  towards  pro-cyclical  budgetary  policies
which amplified rather than  cushioned the effects  of  cyclical  swings.  Sound  public finances
contribute  to  growth  and  employment  notably  by  contributing  to  a  stable  macroeconomic
climate.4 By supporting monetary policy in the pursuit of price stability,  interest rates (both
nominal  and  real)  have  been  low  which  is  conducive  to  private  investment  and  saving.
Moreover,  sound  public  finances  reduce  public  debt  and  consequently  the  interest  burden,
thus  creating  room  for  a  reduction  in  taxes  and/or  an  increase  in  investment  in  productive
public  spending.  Investment  in  physical  (infrastructures),  human  (education,  training)  and
knowledge (R&D and innovation) capital, if well designed, can improve long run output and
growth  potential,  above  all  through  their  beneficial  impact  effect  on  productivity  and
employment.  However,  if  higher  productive  public  spending  is  finances  through  a  rise  in
taxes  or  increased  deficits  and  consequently  higher  public  debt,  private  investment  may  be
crowded-out thus offsetting any potential beneficial effect on growth and employment.

1 

2 

3 

4 

Communication from the Commission on streamlining the annual economic and employment policy co-
ordination cycles, COM(2002) 487 final of 3.9.2002.
Communication  from  the  Commission:  A  project  for  the  European  Union,  COM(2002)  247  final,
22.05.2002. Contribution of Mr. Barnier and Mr. Vitorino to the Convention on the Future of Europe
‘Towards better economic policy co-ordination’, CONV 391/02 of 7.11 2002.
‘Budgetary  challenges  in  the  euro  zone’,  Communication  of  Commissioner  Solbes  in  agreement  with
President Prodi, SEC(2002) 1009/6, Brussels 25 September 2002.
Report  from  the  Commission  and  the  (ECOFIN)  Council  to  the  European  Council  (Stockholm  23/24
March  2001)  ‘The  contribution  of  public  finances  to  growth  and  employment:  improving  quality  and
sustainability’, 12 March 2001, Council Document 6997/01. This was largely based on  a Commission
Communication of the same name COM(2000)846.

2

                                                
A unique rule-based framework for the co-ordination of budgetary policies in EMU has been
established to reflect the fact that the responsibility for the single monetary policy is entrusted
to  an  independent    European  Central  Bank  whilst  responsibility  for  budgetary  policies
remains decentralised in the hands of national authorities. This framework aims at combining
budgetary discipline with flexibility, and is founded on the Treaty requirement  for Member
States to avoid  excessive deficit positions defined as general government deficits below 3%
of GDP and the general government debt level remaining below 60% of GDP (or diminishing
at a satisfactory pace towards the reference value).

In  order  to  reinforce  the  preventive  aspects  of  this  framework  and  to  help  Member  States
avoid excessive deficit positions, the Treaty requirements were complemented by the Stability
and Growth  Pact (consisting of two Council Regulations and solemn  political commitments
enshrined in a Resolution of the 1997 Amsterdam European Council).5 The SGP establishes a
requirement  for  Member  States  to  achieve  and  maintain  budgetary  positions  of  ‘close  to
balance  or  in  surplus’.6  This  is  meant  to  ensure  that  fiscal  policy  contributes  to  an
environment  in  which  monetary  policy  can  effectively  maintain  price  stability  whilst  being
growth  supportive.  Moreover,  by  maintaining  a  budget  position  of  ‘close  to  balance  or  in
surplus’,  Member  States  have  the  necessary  room  for  manoeuvre  for  cyclical  stabilisation
through the working of the automatic stabilisers without the 3% of GDP reference value for
deficits  being  breached.  In  addition,  it  would  lead  to  a  lower  interest  burden,  thus  creating
further scope for governments to pursue growth enhancing reforms.

Overall, the SGP provides an appropriate framework for prudent budgetary management that
is in the economic self-interest of all countries, individually and collectively, irrespective of
EMU or their participation in the euro area. The budgetary objective of ‘close to balance or in
surplus’ provides ample room to allow the automatic stabilisers to operate fully in response to
economic downturns. It is also an appropriate medium and long-term goal given the need for
sustainable public finances  in light of ageing populations. Recent projections show that in the
absence of policy reforms, public spending could increase by between 4% and 8% of GDP in
most countries due to the effects of ageing populations in coming decades.7 This suggests that
some  Member  States  should  consider  running  budget  surpluses  over  the  coming  decade  as
there is a limited window of opportunity prior to the budgetary effects of ageing populations
taking hold. 8

3.

Mixed budgetary performance since 1999

Impressive budgetary consolidation was achieved in the years running up to the launch of the
euro,  with  substantial  declines  in  underlying  budget  deficits  in  most  Member  States  and

5 
6 

7 

8 

OJ L 209 of 2.81997 and OJ C 236 of 2.8.1997.
These budgetary rules are backed up with detailed and regular surveillance procedures. Member States
are required, on an annual basis, to submit stability or convergence programmes in which they set down
a  medium-term  target  that  meets  the  ‘close  to  balance  or  in  surplus’  requirement’  and  an  adjustment
path  towards  it.  The  budgetary  targets  set  down  in  programme,  as  well  as  compliance  with  previous
commitments,  are  subject  to  intensive  peer  review    by  the  Commission  and  Member  States  in  the
Council.
The  timing  and  size  of  the  projected  increase  in  public  spending  varies  considerably  across  member
States.  In  general,  the  increase  in  public  spending  is  projected  to  commence  around  2015  and  peak
around 2040.
Economic  Policy  Committee  (2001):  “The  Budgetary  challenges  posed  by  ageing  populations”,
EPC/ECFIN dd655/01/EN. An overview of how the Commission assessed the sustainability of public
finances in Member States and the main policy conclusions is provided in the report Public finances in
EMU –2002, European Economy Reports and Studies N°3, 2002.

3

                                                
government  debt  being  placed  on  a  downward  trajectory.  This  turnaround  can  in  part  be
attributed to the Maastricht convergence criteria, and demonstrates the potential effectiveness
of EU fiscal rules provided policy actors fully assume their responsibilities.

However, the process of budgetary consolidation has ground to a halt since 1999, and in some
cases  has  reversed.  For  the  euro  area  as  a  whole,  the  favourable  growth  conditions  in  1999
and  2000  were  not  used  to  reduce  underlying  deficits  towards    the  ‘close  to  balance  or  in
surplus’ objective of the SGP. The underlying deficit in  2001  for the euro  area  increased to
1.9%  of  GDP  in  a  context  where  growth  turned  out  to  be  slower  than  expected:  the
deterioration in the underlying budgetary situation  can be attributed to unfunded tax cuts, a
lack  of  control  of  expenditures  and  discretionary  increases  in  public  expenditures  in  some
Member States. The underlying budget position is not projected to improve in 2002.

This aggregate picture hides diverging performances across Member States and a number of
positive achievements. Seven euro area countries and ten EU Member States reached budget
positions  of  ‘close  to  balance  or  in  surplus’  by  2001.  Government  debt  to  GDP  ratios  have
generally  been  on  a  downward  trajectory  with  large  reductions  being  recorded  in  several
Member States. This created room for the automatic stabilisers to operate during the current
economic  slowdown,  which  contrasts  with  previous  downturns  when  governments  had  to
tighten fiscal policies so as to prevent debt levels from entering unsustainable trajectories.  In
addition, several Member States have been able to pursue ambitious tax reform strategies and
some  improvements  have  been  recorded  in  re-directing  public  expenditures  towards  more
productive items that are conducive to growth and employment.

Some Member States, however, have failed to complete the transition to the ‘close to balance
or  in  surplus’  requirement  of  the  SGP..  Deficit  levels  in  Portugal  reached  4.1%  of  GDP  in
2001  and  the  Council  on  5  November  2002,  adopted  a  Decision  on  the  existence  of  an
excessive deficit position. A deficit of 3.8% of GDP  is forecast for Germany in 2002, and the
Commission  has  adopted  a  report  under  Article  104(3)  of  the  Treaty  on  the  risk  of  an
excessive  deficit  position.  The  Commission  has  also  adopted  a  Recommendation  for  the
Council to send  an early-warning to France on account of significant divergence from budget
targets  in  2002  and  because  its  deficit  for  2003  is  projected  to  be  2.9%  of  GDP,  perilously
close to the 3% of GDP reference value.9

There  are  also  worrying  developments  as  regards  government  debt  where  slight  increases
have been recorded in several Member States. Italy and Greece give most cause for concern
as their debt levels remain well above 100% of GDP, very little progress has been made in the
past four years to reduce debt levels towards the 60% of GDP reference value. These Member
States could have been expected to record significant decreases in the debt ratio, but this did
not  materialise  mainly  on  account  of  large  and  persistent  debt  increasing  financial
operations.10 Moreover, these developments have taken place despite the reduction in interest
rates following their membership in the euro area.

4.

9 

10 

Difficulties in the implementation of the SGP

The Commission Recommendation for an early warning is based on Article 6.2  of Council regulation
1466/97  of  1997  on  the  strengthening  of  the  surveillance  of  budgetary  positions  and  the  surveillance
and co-ordination of economic policies.
On  the  basis  of  budget  targets  set  down  by  Member  States  in  their  stability  programmes,  and  taking
account of nominal GDP growth, the debt ratio should have fallen by several percentage points of GDP
per  annum.  This  decline  did  not  materialise,  in  part  because  the  budget  targets  were  missed  and/or
because  of large and persistent debt increasing financial operations.

4

                                                
Based  on  the  experience  of  four  years  in  EMU,  it  is  evident  that  the  existing  rule  based
framework for the co-ordination of budgetary policies remains appropriate and is essential for
the smooth functioning of EMU. The SGP goal of budget positions of ‘close to balance  or in
surplus’ remains an economically valid objective. Furthermore, a rules-based approach to the
co-ordination of budgetary policies that relies on peer pressure can generate results provided
it is accompanied by firm political commitments. However, recent events have highlighted a
number  of  difficulties  with  the  implementation  of  the  SGP,  which  can  be  summarised  as
follows:

(cid:1)  political ownership of the SGP by Member States has diminished. While most countries
continue to subscribe to the goals and objectives of the SGP, in some countries there has
been  a  growing  divergence  between  budgetary  commitments  and  concrete  actions  to
achieve stated targets. There has been an unwillingness to acknowledge the implication of
EMU  on  the  conduct  of  fiscal  policy  at  national  level.  More  generally,  Member  States
have  not  played  their  role  in  exerting  peer  pressure  on  countries  that  miss  budgetary
targets by a wide margin via the enforcement mechanisms of the SGP;

(cid:1) 

(cid:1) 

it  has  been  difficult  to  establish  clear  and  verifiable  budget  objectives  which  take
account of underlying economic conditions. The targets for budget balances of Member
States are set down in stability and convergence programmes in nominal terms. However,
in  assessing  compliance  with  budgetary  commitments,  and  in  particular  the  adjustment
path  to  ‘close  to  balance  or  in  surplus’,  it  is  necessary  to  consider  the  effect  of  the
economic  cycle  on  the  budget  position.  This  has  proved  difficult  in  the  absence  of  an
agreed  method  to  calculate  cyclically-adjusted  budget  balances,  and  also  because  the
nominal  deficit  targets  in  the  programmes  of  Member  States  were  sometimes  based  on
optimistic growth assumptions  and  with  adjustment  efforts  back-loaded  towards  the  end
of  the  time  horizon  of  programmes.  Measuring  compliance  has  therefore  not  been
straightforward and this in turn weakened the enforcement mechanisms of the SGP. This
has resulted  in  the policy debates at EU level  focusing excessively  on  procedural  issues
and relatively minor changes in nominal budget balances, to the detriment of dialogue on
the substantive economic and budgetary policy challenges facing Member States;

the framework for the collection and assessment of budgetary statistics has experienced
a number of difficulties. Of greatest concern are the reporting anomalies detected in some
Member States, which in the case of Portugal led to a very large upward revision of deficit
levels. In addition, ex post revisions to budgetary data are getting larger. There is also  a
need  to  examine  the  discrepancy  between  deficits  recorded  on  accrual  basis  and  debt
issuance in cash terms in some Member States. Finally, the decision making processes of
Eurostat on the classification of certain budgetary operations could be speeded up;

(cid:1)  some  Member  States  did  not  run  sound  budgetary  policies  in  good  times.  A  failure  to
pursue budgetary consolidation in 1999 and 2000 when growth conditions were favourable
led to a deterioration in underlying budget positions and inadequate room for the automatic
stabilisers  to  operate  in  the  subsequent  economic  slowdown.  This  failure  to  allow  the
automatic stabilisers operate symmetrically over the economic cycle illustrates inadequate
surveillance and enforcement mechanisms to deal with unwarranted pro-cyclical loosening
of the fiscal stance;

(cid:1) 

the enforcement procedures of the SGP have been found wanting at critical junctures.
In  particular,  the  early-warning  mechanism  has  not  proven  effective  in  dealing  with
significant slippage from budget targets set down by Member States in their stability and

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(cid:1) 

(cid:1) 

convergence  programmes.  In  addition,  this  needs  to  occur  in  sufficient  time  to  allow
countries to take corrective measures before the 3% of GDP reference value is threatened;

the SGP has struggled to develop into an effective co-ordination framework for dealing
with  country-specific  circumstances  in  a  consistent  manner,  assuring  the  long-term
sustainability of public finances while supporting structural reforms that are designed
to enhance employment and growth potential. Considerable scope exists within the SGP
framework  to  take  account  of  differences  in  the  quality  and  sustainability  of  public
finances across Member States.  But the challenge for the SGP is to move from a case-by-
case  approach  towards  policy  making  based  on  economically  rigorous  criteria  that  are
applied  consistently  over  time  and  across  countries,  and  which  safeguards  the  core
objective of sound and sustainable public finances;

it has been difficult to communicate effectively with  the  press, markets  and the public
on  the  benefits  of  achieving  and  sustaining  sound  public  finance  positions,  and  also
how  the  SGP  works.  This  is  partly  due  to  the  fact  it  takes  time  for  economic  agents  to
adjust to the new policy framework in place since the launch of the euro and also because
the institutional procedures of the SGP are complex. In addition, effective  communication
has  been  hampered  by  conflicting  statements  on  the  appropriate  conduct  of  budgetary
policies. Overall, the difficulty in understanding  the  rationale  of  the  SGP  and  especially
the precise budget commitments set  down  in  stability  and  convergence  programmes  has
weakened external pressure on Member States to run sound budget policies.

5. 

Proposals to improve the interpretation of Stability and Growth Pact

To reinforce the existing mechanisms for the co-ordination of budgetary policies in EMU, the
Commission  presents  five  proposals  which  would  introduce  some  more  flexibility  in  the
interpretation of the SGP, but which at the same time ensure a more rigorous adherence to the
goal of sound and sustainable public  finances. The proposals in  this Communication  can be
achieved within the framework of existing Treaty provisions and SGP Regulations. Therefore,
they  do  not  alter  the  core  budget  requirements  (to  avoid  excessive  deficit  positions)  or
objectives (to achieve and sustain budget positions of ‘close to balance or in surplus’). Neither
do  they  create  new  procedures,  as  upgraded  budgetary  surveillance  will  take  place  on  the
basis of stability and convergence programmes.

i)  Establishing  budgetary  objectives  that  take  account  of  the  economic  cycle.  The
Commission  proposes  that  the  ‘close  to  balance  or  in  surplus’  requirement  of  the  SGP  is
defined in underlying terms throughout the economic cycle, i.e. net of transitory effects and
especially  the  effects  of  cyclical  fluctuations  on  budgets.  The  principle  tool  for  assessing
underlying budget positions will be the common methodology to measure cyclically-adjusted
budget balances which has been agreed by Member States and the Commission.

ii) Transitional arrangements for countries with underlying deficits exceeding the ‘close to
balance or in surplus’ requirement.  In striving to achieve the ‘close to balance or in surplus’
goal of the SGP, the size of budgetary consolidation efforts required of Member States with
underlying  deficits  should  take  account  of  economic  conditions.  The  Commission  proposes
that  a  general  principle  be  established  requiring  countries  with  such  underlying  deficits  to
achieve  an  annual  improvement  in  the  underlying  budget  position  of  at  least  0.5%  of  GDP
each  year  until  the  ‘close-to-balance  or  surplus’  requirement  of  the  SGP  has  been  reached.
This rate of improvement in the underlying budget position should be higher in countries with

6

high  deficits  or  debt.  Also,  a  more  ambitious  annual  improvement  in  underlying  budget
positions should be envisaged if growth conditions are favourable.

iii) Avoiding pro-cyclical budget policies in good times. To avoid a pro-cyclical loosening of
fiscal policies in good times, the automatic stabilisers should operate symmetrically over the
cycle.  This  implies  running  nominal  surpluses  when  economic  conditions  are  favourable.
Effective enforcement procedures are also required to deal with an unwarranted loosening of
fiscal  policies  in  good  times.  As  a  general  rule  expansionary  fiscal  policy  for  stabilisation
purposes, should be confined to Member States that have already created enough  budgetary
room to do so.

iv) The goals of the Lisbon strategy: ensuring that public finances contribute to growth and
employment. The  ‘close to  balance or  in surplus’  requirement could  be  interpreted    to cater
for  the  inter-temporal  budgetary  impact  of  large  structural  reforms  (such  as  productive
investment or tax reforms) that raise employment or growth potential in line with the Lisbon
strategy and/or which in the long-term improve the underlying public finances positions. To
ensure that this interpretation of the SGP does not jeopardise the commitment to sound public
finances, the Commission proposes:
(cid:1)  a small temporary deterioration in the underlying budget position could be envisaged only
if the Member State concerned has already made substantial progress towards the ‘close to
balance  or  in  surplus’  requirement  and  if  general  government  debt  is  below  the  60%  of
GDP reference value. Also, the Member State concerned must demonstrate in its stability
or  convergence  programme  that  there  are  clear  economic  and  budgetary  benefits
attributable  to  the  proposed  reform.  In  assessing  the  programme,  the  Commission  must
ascertain that there is a  clear and realistic deadline for returning to a position of “close to
balance or in surplus” within the time horizon of the stability or convergence programme.
Budgetary projections must be based on a sound and prudent macroeconomic scenario to
be verified against those of the Commission, with due account taken of the need to avoid
inappropriate  pro-cyclical  policies.  An  adequate  safety  margin  must  be  provided  at  all
times to prevent nominal deficits from breaching the 3% of GDP reference value. Finally,
the Member State concerned should commit to introduce the necessary corrective measures
in the event of a failure to stick to the adjustment path for returning to a budget position of
‘close to balance or in surplus’.

(cid:1)  a  small  deviation  from  the  ‘close  to  balance  or  in  surplus’  requirement  of  a  longer-term
nature could be envisaged for Member States where debt levels are well below the 60% of
GDP  reference  value,  and  when  public  finances  are  on  a  sustainable  footing.  This  will
require  a  careful  assessment  to  be  made  of  outstanding  public  debt,  contingent  liabilities
(such as implicit pension obligations) and other costs associated with ageing populations.
An adequate safety margin must be provided at all times to prevent nominal deficits from
breaching the 3% of GDP reference value.

v) The sustainability of public finances should become a core policy objective. Sustainability
concerns  should  be  explicitly  taken  into  account  when  assessing  the  budget  positions  of
Member States under the SGP. To  this  end,  greater  weight must be attached  to  government
debt ratios  in  the  budgetary  surveillance  process.  The  debt  criterion  of  the  excessive  deficit
procedure, which requires debt levels above 60% of GDP to approach the reference value at a
‘satisfactory  pace’,  should  be  made  operational.  Countries  with  debt  levels  well  above  the
60% of GDP reference  value  should outline a detailed  strategy  to  reduce  their  debt  level  to
below the reference value in their stability and convergence programmes. The assessment of
the sustainability of public finances as part of stability and convergence programmes should

7

be  upgraded,  with  firm  policy  conclusions  as  to  whether  the  budgetary  policies  ambitious
enough to meet the challenge posed by ageing populations. As part of a comprehensive three-
pronged  strategy  to  prepare  for  ageing  populations  (i.e.  debt  reduction,  raising  employment
rates of women or older  workers,  and  reform  of  pension  and  health  care  systems),  Member
States in their stability or convergence programmes should consider running budget surpluses
in coming  years,  i.e.  over and above the ‘close  to  balance  or  in  surplus’  requirement  of  the
SGP. Finally, Member States and the Commission should intensify efforts to produce revised
projections of the budgetary impact of ageing populations by 2005.

6. 

A  four-point  programme  to  improve  the  implementation  of  the  Stability  and
Growth Pact

The difficulties in the implementation of the SGP described above cannot be resolved simply
by  adjusting  the  interpretation  of  key  provisions.  To  be  effective,  fiscal  rules,  need  to  be
accompanied with:
(cid:1)  a  firm  political  commitment  of  all  parties  concerned  to  adhere  to  their  budgetary
commitments  at  EU  level  and  to  exercise  their  role  in  the  process  of  peer-review  and
enforcement;

(cid:1)  timely and high quality  analysis of the  economic and budgetary conditions so that policy

conclusions are based on reliable data and firm analytical underpinnings;

(cid:1)  effective enforcement procedures that address slippage from agreed budgetary targets  in a

timely and robust manner;

(cid:1)  measures  to  improve  communication  so  as  to  enhance  the  external  pressure  on  Member

States to run sound fiscal policies.

To  strengthen  the  implementation  of  the  SGP,  the  Commission  proposes  that  the  following
four-point programme be agreed in time for the 2003 Spring European Council.

i) Member States should reaffirm their political commitment to the SGP in a “Resolution to
reinforce the  co-ordination of budgetary policies” to be endorsed by the European Council
at  their  meeting  in  Spring  2003.  The  Resolution  would  represent  the  solemn  political
commitment  of  the  Commission,  Member  States  and  Council  to  implement  the  SGP  in
accordance  with  the  proposals  set  down  in  this  Communication.  It  could  make  explicit  the
criteria  for  interpreting  key  SGP  provisions,  e.g.  that  the  ‘close  to  balance  or  in  surplus’
requirement  is  assessed  in  underlying  terms,  that  countries  with  underlying  deficits  must
achieve an annual rate of underlying budgetary consolidation of at least 0.5% of GDPand that
countries with a very high level of debt must respect a satisfactory pace of debt reduction. In
addition, it could establish a firm political commitment that a more flexible application of the
‘close to balance or in surplus’ requirement would only be envisaged if strict conditions and
safeguards  are  met.  Finally,  the  Resolution  could  set  down  commitments  on  the  part  of
Member  States  to  respect  certain  behavioural  norms  in  the  co-ordination  of    budgetary
policies at EU level, e.g. to take due account of the implications for the euro area when setting
budgetary policies at national level,  to  play their role in the process of peer  pressure and in
particular facilitate the implementation of  the enforcement procedures of the SGP .

ii) Upgrading the analysis of economic and budgetary polices. The following measures are
needed to upgrade economic and budgetary surveillance at EU level:

8

(cid:1)  the quality and timeliness of government finance statistics need to be improved as they are
the foundation on which budgetary surveillance is built. The Commission proposes that a
‘Code of best practices on the reporting of budgetary data’ be endorsed by the (ECOFIN)
Council in time for the next excessive deficit procedure reporting of 1 March 2003 and the
2003 Spring European Council11. Member States should commit themselves in the Code to
adopt  practices  that  upgrade  the  quality,  transparency,  timeliness  and  reliability  of
budgetary  statistics.  The  Code  will  also  clarify  and  streamline  the  procedures  to  be
followed by the Commission to ensure a more effective, timely and transparent action in its
role as statistical authority in this domain;

(cid:1)  it  is  essential  that  greater  reliance  on  underlying  budget  positions  in  the  EU  surveillance
process  be  accompanied  with  an  improved  analysis  of  Member  States’  budget  positions.
This is because in contrast to the actual budget balance, the underlying budgetary position
is not directly observable.  The key challenge is to distinguish budgetary components that
have more permanent effects from purely short-term transitory elements. The Commission
and  the  Council  have  developed  a  method  to  cyclically  adjust  budget  balances  (CAB)
based on a production-function approach to estimating output-gaps, and this will be used as
the  starting  point  for  an  assessment  of  the  underlying  budget  position.12  Nonetheless,  a
degree  of  caution  must  be  exercised  when  interpreting  changes,  especially  on  an  annual
basis,    given  the  complexity  and  imprecision  when  measuring  cyclically  adjusted  budget
balances.  In assessing whether the budgetary commitments set down by Member States in
their  stability  and  convergence  programme  meet  the  requirements  of  the  SGP,  the
Commission  will  use  its  own  forecast  to  assess  the  realism  of  the  macroeconomic
assumptions on which the budgetary  targets are based. To ensure a consistent assessment
across Member States, the Commission proposes that the ‘Code of conduct on the content
and  presentation    of  stability  and  convergence  programmes’13be  updated  also  to  require
Member States to provide information on important one-off budgetary operations.

(cid:1)  in assessing stability and convergence programmes, more attention needs to be paid to the
quality  of  public  finances.  The  emphasis  should  also  be  on  whether  the  composition  of
proposed  budgetary measures is conducive  to  growth  and employment,  and  also  whether
they are likely to achieve a sustainable improvement in the budget balance. Inter alia, this
involves  examining  the  balance  between  tax  increases  and  expenditures  cuts  to  achieve
improved budget balance, the overall dynamic and composition of public expenditures and
whether they favour productive items, the impact of tax reforms, and finally the degree to
which  consolidation  relies  on  one-off  budget  measures  which  cannot  be  expected  to
achieve a sustained improvement in public finance positions;

(cid:1)  the Commission intends to reinforce its surveillance of Member States’ economies, and in
particular to concentrate on countries which have difficulties in meeting the requirements
of the SGP. The Commission will organise more frequent and comprehensive missions to
the Member State. Also in-depth country studies shall be carried out and made public. 14

11 

12 

13 

14 

Communication from the Commission on the need and the means to upgrade the quality of budgetary
statistics. COM (2002) 670 of 27.11.2002
Economic  Policy  Committee  (2001),  “Report  on  a  potential  output  and 
ECFIN/EPC/670/01
The revised Code of Conduct, endorsed by the ECOFIN Council in July 2001, along with an assessment
of how it has worked, is published in Public finances in EMU – 2002.
For example, see Directorate  General for Economic and Financial Affairs (2002): ‘Germany’s growth
performance in the 1990s’, Economic Papers N° 170.

the  output  gap”,

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iii)  More  effective  enforcement  procedures.  The  Treaty  and  SGP  provide  a  range  of
surveillance enforcement mechanisms for dealing with slippage’s from budgetary targets To
ensure that they are operational, the Commission proposes:
(cid:1)  to specify the criteria that the Commission will use when deciding whether to activate the
early-warning  mechanism  in  the  event  of  significant  divergence  from  budgetary  targets,
which  in  turn  would  be  used  by  the  Council    in  deciding  whether  to  endorse  the
Commission Recommendation. Three factors should be taken into account, namely the size
of  the  budgetary  slippage  (extent  to  which  budget  positions  diverge  from  the  targets  set
down in stability or convergence programmes), whether the divergence of actual balances
from target can be explained by cyclical or discretionary factors, and thirdly the possibility
of deficits rising and approaching the 3% of GDP reference value. These proposals would
imply  that  an  early-warning  could  be  sent  to  a  Member  State  even  if  its  nominal  or
underlying budget balance is some way below the 3% of GDP reference value.

(cid:1)  that an inappropriate pro-cyclical loosening of the budget in good times (taking account of
the  starting  budgetary  position  and  monetary  conditions  facing  the  country  concerned)
should be viewed as a violation of budgetary requirements at EU level, and should lead to
an appropriate and timely response through the use of instruments provided in the Treaty.

(cid:1)  to  clarify  the  interpretation  of  the  debt  criterion  of  the  excessive  deficit  procedure,15  i.e.
what  would  constitute  a  ‘satisfactory  pace’  of  debt  reduction  towards  the  60%  of  GDP
reference value. For instance, an appropriate pace of debt reduction would be the reduction
of  the  debt  ratio  resulting  from  compliance  with  the  ‘close  to  balance  or  in  surplus’
requirement  of  the  SGP.  On  the  basis  of  a  defined  ‘satisfactory  pace’  and  in  accordance
with  the  Treaty,  the  failure  on  the  part  of  a  high  debt  country  to  achieve  the  established
pace  of  debt  reduction  should  lead  to  the  Commission  to  activate  the  excessive  deficit
procedure  and  prepare  a  report  under  Article  104(3).  In  assessing  compliance  with  this
requirement,  the  Commission  will  examine  all  the  components  that  drive  debt
developments, as the pace of debt reduction depends upon some factors that can be shaped
by  government  policies  and  other  factors  which  lie  outside  governments’  immediate
control.

These improvements can be brought about within the existing Treaty and SGP framework, via
supplementary provisions in the existing ‘Code of Conduct on the content and presentation of
stability  and  convergence  programmes’.  In  a  longer-term  horizon,  the  enforcement
mechanisms  of  the  EU  budgetary  surveillance  process  can  be  further  strengthened  by
adopting the relevant proposals made by the Commission to the Convention on the Future of
Europe.  Inter  alia,  the  Commission  could  be  given  the  authority  to  issue  early  warnings
directly to Member States without recourse to a Council vote: this could lead to more direct
and timely signalling of budgetary problems.

iv)  Better  communication  through  openness  and  transparency.  Reliable  and  timely
information must be given on the budgetary commitments of Member States and on how the
SGP is being implemented. Responsibility for improved  communication lies  with  all actors.

15 

Article  104(2)  of  the  Treaty  on  the  excessive  deficit  procedure  states  that  “The  Commission  shall
monitor the development of the budgetary situation and of the stock  of  debt  in  Member  States  with  a
view to identifying gross errors. In particular it shall examine compliance with budgetary discipline on
the basis of the following two criteria …whether the ratio of government debt to gross domestic product
exceeds a reference value [60% of GDP], unless the ratio is sufficiently diminishing and approaching
the reference value at a satisfactory pace.”

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The  Commission  already  publishes  an  annual  report  on  Public  finances  in  EMU  and  also
provides  some  details  of  its  assessment  of  stability  and  convergence  programmes  in  press
releases.  However,  there  is  scope  to  enhance  the  flow  of  information.  For  its  part,  the
Commission  intends  to  make  public  its  detailed  assessment  of  stability  and  convergence
programmes.  Also,  the  Commission  in  July  each  year  will  publish  a  mid-year  review  of
budgetary  developments  in  the  Quarterly  Report  on  the  Euro  area.  This  will  examine  how
Member  States  are  faring  in  meeting  their  budgetary  targets.  It  will  also  provide  an
assessment of economic conditions and prospects, as well as general orientations of budgetary
policies  which  Member  States  should  take  into  account    in  preparing  their  annual  budgets
during the autumn months.

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