The effectiveness of fiscal rules crucially hinges on their enforceability. This notion looms large in the relevant literature starting with the seminal work by Kopits and Symansky (1998), who characterised the stylised profile of an ‘ideal’ fiscal rule. It also applies to the Stability and Growth Pact (SGP), a coordination device of the EU aimed to ensure the smooth functioning of the Economic and Monetary Union (EMU).
From today’s perspective, the track record of the SGP has been mixed at best. Since inception, some member states have regularly and significantly deviated from the course of action implied by the EU fiscal rules (Larch et al. 2023). Yet, despite a dismal compliance record by a comparatively small group of countries the EU never managed to deploy the financial sanctions set out in the SGP.
Right now, the EU’s fiscal framework is on the cusp of a new legislative reform – the fourth – where the objective of strengthening enforcement features prominently once again. The official narrative underpinning the reform proposal underscores stronger enforcement via a more consistent recourse to financial sanctions as the necessary counterweight to more flexible and country-specific fiscal adjustment requirements.
Drawing on basic elements of game theory, in a recent paper we show that all valiant attempts to strengthen the SGP’s enforcement will produce limited effects unless a number of politically charged but fundamental issues are addressed (Kirchsteiger and Larch 2023). The EU needs to find credible ways to (i) consistently impose meaningful sanctions in the event of non-compliance; (ii) link financial support in the wake of major shocks to a meaningful but not too harsh degree of macro-conditionality; and, most importantly, (iii) strengthen the resilience of member states to major economic shocks.
The underlying problem of the SGP’s enforcement dilemma is straightforward: countries with a time-tested preference for looser fiscal policy know the risks of non-compliance with the EU fiscal rules are not random, ensuring a blocking minority against the imposition of sanctions. They also know that in the event of a very large negative shock, their own fiscal vulnerability can produce collateral damage for the fiscally prudent countries. Hence, when standing on the brink of a much bigger adversity, the prudent countries will accept paying for the survival of the EMU even if they formally committed not to do so.