The ensuing reform of the Pact in 2005 thus ushered in a greater degree of tolerance, and political influence was permitted in dealing with EU member states’ fiscal imbalances. It is true that the average deficit ratio in the euro area improved through 2007, aided by the upswing in economic conditions. However, only a few countries earnestly engaged in substantial budgetary consolidation efforts. At the same time, financial market scrutiny was mild, and as a result the less fiscally-responsible governments were able to meet their borrowing requirements at a relatively small spread on the benchmark interest rate. This changed after 2007, when the onset of the financial crisis found several Member States poorly prepared for what lay ahead. It became difficult to undo the accumulated imbalances and vulnerabilities. The debt burden worsens when the interest rate exceeds the growth rate of the economy. This is reinforced when the primary balance is in deficit, in which case the dynamics of servicing the debt could easily make the debt burden unsustainable. Fiscal consolidation, which is necessary even in less serious circumstances, carries the risk of downward macroeconomic adjustment. In today’s circumstances, there is the danger of a vicious cycle in the form of a negative macroeconomic spiral. This is because weak economic growth leads to lower government revenue that raises the fiscal deficit ratio, and therefore requires further budgetary tightening. 2  L. Schuknecht, Ph. Moutot, P. Rother and J. Stark “The Stability and Growth Pact, Crisis and Reform” ECB Occasional Paper Series, No. 129, September 2011.

According to Smets, all of this indicated that financial stability should be an explicit objective of monetary policy, but that it should be used as a last resort in situations where macroprudential policy and other regulations are not fully successful. The American economist Michael Woodford illustrated in a simple model why monetary policy should in certain situations take account of financial imbalances, even if this  14 See Stock and Watson (2002). In the international economic policy discussion, "the great moderation" or "the  great calm" usually refers to the period from the mid-1980s until 2008. In Sweden, economic development did not become more stable until a little way into the 1990s. See also Hansson, Nessén and Vredin (2018). 15 See Rajan (2005). 16 See Borio and Lowe (2003). 17 See Jonsson and Moran (2014), who show in a model that a positive supply shock can lead to subdued prices, while the output gap and credit gap rise. 18 See Smets (2013) and Woodford (2012). See also the report “Rethinking Monetary Policy” by Eichengreen et al. (2011), which discusses the implications of the financial crisis for central banks. 13 [30]  may mean less favourable target fulfilment for price stability and macroeconomic stability in the short term. Other economists, such as Lars Svensson, argued that monetary policy should continue to focus solely on price stability and macroeconomic stability.19 He said that monetary policy and policies to promote financial stability are distinct and separate policy areas with different objectives, different means and different responsible authorities.