Economic Policy Coordination in the European Union

By Begg, Iain; Hodson, Dermot et al. | National Institute Economic Review, January 2003 | Go to article overview
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Economic Policy Coordination in the European Union


Begg, Iain, Hodson, Dermot, Maher, Imelda, National Institute Economic Review


There are differing views about the need for economic policy coordination in the EU and about the adequacy of the system that has evolved under EMU. This article examines the case for such policy coordination, then describes and assesses the current arrangements for both 'hard' coordination -- epitomised by the much-maligned Stability and Growth Pact (SGP) -- and the 'soft' forms of coordination that have evolved in the EU to complement formal rules. Although the system achieves more than is sometimes recognised, it is shown to have weaknesses. Options for reforming the SGP and other facets of the system are discussed.

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A crucial question for the success of EMU is whether the combination of a monetary policy set by an independent, supranational central bank and fiscal (and other) policies controlled by national governments is conducive to both price stability and economic growth. Since the inception of the euro in 1999 and even during the period of convergence that preceded it, there has been a steady stream of criticism about the EU'S machinery for economic policy coordination (Buiter et al., 1993; Eichengreen and Wyplosz, 1998). The Stability and Growth Pact (SGP) -- one of the most prominent facets of coordination -- has consistently been lambasted by economists as an ill-conceived, blunt and ultimately counter-productive set of rules that encourage procyclical fiscal policy, inhibit economic recovery and damage the long-term growth potential of the EU economy. The charge sheet also cites the inability of the policy system to deliver a coherent policy mix and bemoans the lack of flexibility in the conduct of policy. Subtl y, too, the effectiveness of the EU's fiscal policy rules has become an unofficial sixth test for the UK to sign-up to the euro.

Macroeconomic policy in the Keynesian tradition, as articulated by the likes of James Meade and Jan Tinbergen, conceived of the policy mix as a means of assigning the available policy instruments to a range of macroeconomic target variables. In the simplified systems of simultaneous equations used to model this mix, the number of instruments had to be at least as great as the targets. The Euro Area system is altogether different. Monetary policy is assigned to the ECB, which has strong independence, and is meant to focus primarily on the price stability of the Euro Area as a whole. Fiscal policy, by contrast, remains with the Member States and is meant to be the means by which individual economies adjust the demand-side of their economies to reflect national divergences from the Euro Area average. The essential problem at the European level is how to ensure that there is compatibility between the single monetary policy and the potentially divergent national fiscal policies (and, indeed, other dimensions of ec onomic policy).

Policy coordination can be defined in this context as supranational rules or norms which are agreed by all Member States, leave primary responsibility for the policy area with national authorities, but set limits on their discretion. Action to enforce the rules or, at least, to assure conformity with the spirit of shared policy aims will be triggered if there is a failure to keep within the parameters set by the legislation. For example, there are Treaty commitments to avoid excessive deficits that apply to all Member States (including those not participating in the euro), with sanctions if they fail to do so: this can be characterised as 'hard law' coordination. A different approach relies solely on soft law measures (such as naming and shaming governments) without the back-up of explicit formal rules.

Despite impressions to the contrary, the procedures for policy coordination in the EU are quite extensive (for an overview, see European Commission, 2002a). Article 99 of the European Community Treaty calls on Member States to regard economic policy as a matter of common concern and to coordinate their policies within Council (and through a range of committees and mechanisms) with a view to achieving, inter alia, stable and noninflationary growth.

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