final final SGP

1
Tyler Furnari
Professor Warin
Economics of the EU
Final Working Paper
The Future of the Stability and Growth Pact of the EMU
The ultimate step towards a European Economic and Monetary Union was
initiated by the Treaty of Maastricht in 1992. Thus, the Treaty of Maastricht set the
architecture of the implementation of an EMU in the European Union. However, during
the Conversion Period (1993-1998) many larger member states, such as Germany, needed
a reassurance that all other member states would continue to practice fiscal discipline
after the EMU was completed in 1999. This widespread political skepticism led to the
creation of the Stability and Growth Pact, which was formally voted and adopted by the
European Council during the Treaty of Amsterdam in 1997. Its goal was to reconcile the
problem of fiscal discipline in the future EMU, by ensuring the fiscal discipline of the
EMU that had been established by the Treaty of Maastricht. Overall the SGP was the
European Union’s answer to controlling the fiscal policy of EMU member states, and
eventually all of the European Union.
The key components of the Stability and Growth Pact were the two council
regulations and the resolution of the European Council of June 17th
, 1997 on the SGP.
The Council’s regulation (EC) No 1466/97 addressed the preventive arm of the SGP by
stating “the strengthening of the surveillance of the budgetary positions and the
surveillance and coordination of the economic policies.” The second regulation of the
European Council would define the “dissuasive or corrective arm” of the SGP, thus
addressing the issue of “Speeding up and clarifying the implementation of the excessive

2
deficit procedure.” In essence these two arms were the basis of the fiscal criterion that
would come to define the SGP.
There was a great deal of rationale behind the creation of the SGP. The most
significant goal was to anchor the fiscal discipline of the EMU members, in order to
allow the European Central Bank (ECB) to maintain price stability throughout the EU. In
addition, the presence of the SGP would reduce the problem of “free-riding” and “spill-
over” effects due to irresponsible excessive deficit spending by individual member states.
Another important goal of the SGP was fostering the credibility of the ECB because the
new euro would need to gain the trust of the world financial market in order to succeed in
the end. All in all, having the SGP would help produce an economic market of low
inflation and low interest rates that according to the European Council would induce
sustainable growth and employment in the greater European community.
Subsequent, to both political and economic debates at the Treaty of Amsterdam,
the economic policy framed by the Stability and Growth Pact would be based on four
rules: the ECB would be fully independent from any political motives, there would be no
“bail out” of national government deficits, along with no monetary financing of deficits,
and member states would avoid “excessive deficits” as much as humanly possible. All of
these rules would be practiced according to the fiscal criterion of the SGP, which stated
that member states could not exceed an annual deficit to GDP ratio of 3%. The focus on
the deficit criterion was implemented to reduce the debt of all member states to 60% of
GDP or lower.
The implementation of the SGP at the beginning of EMU in 1999 stimulated the
great heated economic debate about the weaknesses and strengths of the SGP’s fiscal

3
criterion. Innumerable economists pleaded their alternative policies, which they believed
would help strengthen the implementation and credibility of the SGP within the EMU.
Due to the continual breaching of the SGP’s deficit ceiling by larger member states, such
as France and Germany, and the continual challenges to the credibility of the SGP in its
early stages, the European Council finally convened in March 2005 to revise the SGP.
On March 20th
, 2005 the European Council endorsed the first phase of the “new SGP” or
“SGP II”. This adoption was a report entitled “Improving the Implementation of the
Stability and Growth Pact.” The meeting at Brussels declared that the basic rules of
infrastructure of the Treaty of Amsterdam would be retained, thus maintaining the
original fiscal criterion of the SGP.
Furthermore, the European Council’s March report seemed to be relaxing both the
preventive and corrective arms that essentially comprised the foundation of the SGP. For
example, the Brussels meeting led to no decision on the annual limit of the deficit,
alongside the extension of countries breaching the 3% deficit ceiling having a period of 5
years to correct their “excessive deficits”. The most arbitrary revision was the political
compromise of countries being able to exceed the deficit ceiling of 3% if their excess
spending could be claimed to “achieve European policy goals” or “foster international
solidarity”.
However, the “new SGP” was finally formulated after several amendments by the
European Council were made to the EC regulations 1466/97 and 1467/97 on June 27th
,
2005. The amending regulation of ( EC) No 1466/97 or the “preventive arm” of the SGP
was considered to be strengthened. The Amendment addressed the issue of economic
and budgetary diversity within the EMU by allowing “country-specific” medium term

4
objectives to be created. This change in policy would allow the SGP criterion to take into
account each individual member state’s unique domestic situation. Thus, this MTO could
diverge from the “close to balance or in surplus” budgetary paths temporarily. Moreover,
each specific MTO would allow individual member states to deal with cyclical
fluctuations in their national economy, which should help correct the criticism of the SGP
criterion not allowing more room for budgetary maneuver i.e. social reform, public
investment, and other structural reforms. Overall, the “preventive arm” of the “new
SGP” would put more emphasis on the goal of long term sustainability than the original
SGP by creating “country-specific” MTO’s to allow for more structural reform.
The (EC) No 1467/97 amendment addressed the “corrective or dissuasive arm” of
the original SGP. Essentially, it concerned the implementation of the “excessive deficit
procedure” of the SGP. Thus, this amendment relaxed the “EDP” more than the original
SGP. For instance, the procedural deadlines for the EC were extended to allow more
time for member states to implement the necessary economic action to their budgetary
procedure. This directly resulted in the decision to allow the EC four months instead of
two months to decide whether an “excessive deficit” had been committed by a member
state of the EMU. In addition, the amendment stated that if member states take effective
action by following the recommendation of the EC and adverse economic effects
interfere with the success of the implementation, then the EC can produce a revised
notice of recommendation. Furthermore, the maximum period of imposing sanctions in
the EDP was extended from 10 months to 16 months after the European Commission’s
recommendations had been ignored by the European Council. Exceptions to the
breaching of the “excessive deficit” ceiling would be extended if the European

5
Commission and the European Council felt that the excess over the MTO reference value
by a member state could be attributed to a severe economic downtown ( recession).
Lastly, special considerations for long-term structural policies, and contributions
fostering European policy goals would be considered and imbedded in the MTO. In
summary, the “corrective or dissuasive arm” of the pact “ ensures that gross policy errors
as opposed to economic “bad luck” are identified and penalized” ( Warin, 1).
Prior to the establishment of the “new SGP” or “SGP II” there were many
alternatives and criticisms expressed by prominent economic scholars throughout the
world. As an economist one must shed light on several working papers before delving
into the economic literature “post SGP II”.
Middlebury Professor of economics Thierry Warin published his working paper
“Should Europe Get Rid of the SGP” in September 2004. The paper specifically called
attention to the inability of larger EMU member states to abide by the SGP deficit ceiling
criterion because of their bias towards implementing national structural reforms through
fiscal policy. In addition, Warin brought up the fact that SGP I was a compromise
between politicians and EU economists. “A rule like the SGP, aimed at sanctioning
spendthrift governments, has been viewed as a good compromise: able to bring about
fiscal policy while providing governments with needed flexibility during temporary
output decreases” ( Warin 2004, 9). The paper realistically defined the only economic
tool left to national governments to be structural reform. Thus, the SGP forced the
national governments of EMU member states to reform the structure of their economies,
however the inability of countries to specifically run a deficit to GDP ratio of 3% was
essentially impossible because of the ex post property of GDP.

6
In January 2005 Professor Warin published “ Stability and Growth Pact: An
Index to Trigger an Early Warning System?” proposing a new early warning procedure
as part of the “preventive arm” of the SGP. This paper again drew on the fact that the
SGP is an “ex post facto” rule “Because the SGP is calculated over GDP and countries
cannot know the precise level of future gross domestic products, it is almost impossible
for countries to target a deficit of 3% of GDP” ( Warin 2005, 6) This specific flaw
addresses the problem of the output gap when it comes to countries trying not to breach
the deficit criterion of the SGP. Thus, if the actual GDP for any reason is lower than the
projected or forecasted GDP, the country may breach the pact. Warin’s modification of
SGP I would be to establish a realistic and early effective response to member states that
are in jeopardy of breaching the SGP deficit criterion. According to Warin, the EC could
simply recalculate the 3% deficit based on lagging the GDP by one year. In doing so the
EC would have a better index to forecasts GDP in the future. This would help ameliorate
the problem of the output gap in EMU member states.
Also in early 2005 Assar Lindbeck and Dirk Niepelt published their collaborative
working paper “Improving the SGP: Taxes and Delegation Rather Than Fines”. The two
economists put forth the alternative of creating corrective taxes instead of fines in order
to change the view of Europeans when it came to their politicians practicing imprudent
fiscal policy. In essence, this could better restrain politicians from buying votes, due to
the fact their citizens would contemplate the consequences of higher taxes, if their
national government breached the deficit criterion of the SGP. It also would be easier to
downplay the “political drama” associated with fines, along with the economic
abruptness that fines would provoke on a member state’s domestic economy. Ironically,

7
we have two economists thinking like politicians by substituting taxes for fines, thus
believing that a simple change in the SGP’s rhetoric would bring dramatic changes in
European behavior. Lindbeck and Niepelt also proposed a framework allowing
countries with smaller debt quotas to run larger deficit quotas and vice versa. This would
provide more of a “carrot” to member countries who abided by the fiscal discipline of the
Pact. The two economists also suggested the creation of an EMU fiscal policy committee
that could forecasts and supervise member states’ budget outlooks. Something in
comparison to the Congressional Budget Office of the United States as referred to by
Lindbeck and Niepelt.
The majority of criticism that preceded the “new SGP” is still very prevalent in
post SGP I economic debate. However, the main diverging factor between economists
regarding “SGP II” is its complexity that leaves it open to such great discretion by EMU
member states. The main question is whether or not the discretionary nature of “SGP II”
will be its own demise, but beforehand we must understand the opposing views
surrounding the “SGP II”.
Immediately following the March 2005 European Council Agreement Harvard
Professor of economics, Martin Feldstein, published a short working paper severely
criticizing the EC’s measures to improve the SGP I. The Council’s agreement entitled,
“Improving the Operation and Implementation of the Stability and Growth Pact”
maintained the basic rules of SGP I: a maximum budget deficit of 3% of GDP and
maximum debt to GDP ratio of 60 percent. Feldstein’s problems were not related to the
“preventive arm” of the SGP, but rather the EC’s modifications of the “corrective arm” or
“excessive deficit procedure”. He felt that the absence of an annual limit on the deficit

8
would result in the majority of EMU member states inevitably breaching the fiscal deficit
criterion. In addition, the EC’s decision to allow countries in violation of breaching the
deficit ceiling a period of five years to get back under it, only would exacerbate the “SGP
II’s” lack of credibility. Moreover, the EC’s exceptions when calculating member states’
budgets allowed for EMU countries to “legitimately exceed the three percent ceiling (and
presumably the 60 percent debt limit) if the spending that causes that violation is deemed
to aim to “achieve European policy goals” or “foster international solidarity” (Feldstein,
8). Overall Feldstein believes that the discretionary nature implemented by the EC’s
March agreement threatens the fiscal stability of the EMU. In his opinion, the EC has
done absolutely nothing to solve the independent fiscal decision making within the EMU.
As for the discretionary nature of the “SGP II” Feldstein concludes his paper by stating,
“The danger looking forward is that each country will find ways to rationalize growing
fiscal deficits, comfortable in the knowledge that there will be no formal pressure from
other EMU countries and that the interest rate effects will be the same for all EMU
countries” (Feldstein, 9).
One must keep in mind the time in which Professor Feldstein wrote his caustic
review of the EC’s measures to improve the SGP I. Nonetheless, even after the two
amendments made to EC regulations 1466/97 and 1467/97 there are many economists
that side with Feldstein’s analysis. The most recently published economic literature on
the reform of the SGP I was published by economist Christian Deuber in March 2006
entitled “A Dynamic Perspective for the Reform of the Stability and Growth Pact”.
Deuber strongly concurs with Feldstein’s prior analysis by severely undermining the
“SGP II’s” rhetoric. He questions the precise definitions embedded in the excessive

9
deficit procedure, such as a “severe economic downturn”, and “an exceptional and
temporary breach”. The more lenient assessment of the EDP, only entices countries to
justify their imprudent fiscal policy. Furthermore, Deuber criticizes the “exceptional
circumstances” that are exempted from budget calculations because they are largely
linked to “old requests from certain member states which had demanded more leniency
under the SGP” (Deuber, 29). Thus, the exemptions from calculating the deficit of
member states’ have been too overly appeasing to national governments. Deuber also
doubts that the new “SGP II” will facilitate the implementation of sanctions and fines by
the European Council. His siding with Feldstein is unified through his SGP II review
when he states, “The institutions and procedures have not been changed, the incentives
and disincentives which they contain, have not been altered either. The member states
continue to be their own judges as to their mutual budgetary performance” (Deuber, 29).
On the other hand not all contemporary European economists have such a one-
sided view on the future of the “SGP II” in the EMU. Following the amendments of the
EC regulations in June 2005 economists Marco Buti, Sylvester Eijffinger, and Daniele
Franco published “ The Stability Pact Pains: A Forward-Looking Assessment of the
Reform Debate”. There combined assessment argued that the reform of the SGP was a
mixture of “pros and cons”. The pros focused largely on the “preventive arm” of the
SGP and its emphasis on long-term economic sustainability. They believed that the
“preventive arm” made the fiscal rules of the SGP less “myopic” and thus provided the
necessary amount of flexibility in dealing with special asymmetric shocks because of the
creation of “country-specific” medium term objectives (MTO). All in all, the
transparency had improved, although there is still much further room for future progress.

10
However, this collaborative assessment by Buti, Eijffinger and Franco expressed
several cons still relevant after the “SGP II”. The first addressed the continual lack of
availability of high quality statistics and “timely fiscal indicators”. Moreover, the second
major con of the “SGP II” was that in order for the MTO’s to be successful better
economic indicators need to be implemented to give “early warnings” of deviations from
MTOs. Finally, their assessment was directed toward the discrepancy surrounding the
“excessive” rules of the EDP of the “protective arm”, which may give countries more
leeway to escape sanctions for breaching the reference deficit value of 3% of GDP.
Middlebury professor of economics Thierry Warin’s unpublished working paper
entitled “Stability and Growth Pact” infers that the new “SGP II” is essentially stricter
than its predecessor. Warin believes that the “preventive arm” of the “SGP II” was given
some credibility because of the creation of “country-specific” MTOs. The MTO was to
provide a margin with respect to the reference value of the 3% deficit of GDP.
According to Warin the MTO gives greater market fluctuations, but tighter fiscal policy.
This is due to the fact that the original infrastructure of the SGP was retained, even
though in an ideal economic world it would have been revised. Instead political and
economic factors have again created a complex hybrid that pretends to be the solution to
the problems of the original SGP.
All in all, the heated economic debate around the newly revised “SGP II” will
perpetually exists until its further reformation. Even so contemporary economists can try
to evaluate past statistical data to predict the uncertain future of the “SGP II” in the EMU.
This process of statistical evaluation can be done through econometrics by running
regressions. This will be the goal of the rest of this paper. Now having a widespread

11
understanding of the economic literature on the SGP I and the revised SGP II, I will
attempt to solve which side of the dividing economic argument is more realistic in the
future. Will the robustness of the “preventive arm” of the new “SGP II” outweigh the
potential negative implications being predicted by the Feldstein’s of the world.
Hopefully my results will give us a more clear answer to this debate.
Model:
The goal of my model is to discover, which economic variables of the EMU
member states affects their budget deficits the greatest. To do this I will evaluate
previous budgets of EMU and non-EMU countries to see how they have differentiated
over the years. Thus, I will conduct a cross-sectional time series analysis on the
Europeanization period (1978-1992), the conversion period to EMU (1992-1998), and
then the EMU period of the SGP (1999-2004) for 15 countries. These 15 countries will
consist of all the 12 EMU countries up to today, and 3 non-EMU countries which are
Denmark, Sweden and the United Kingdom. These non-EMU countries will allow me to
compare the costs and benefits of being within EMU (Euro zone). I will run my
regressions using the software Stata 9.0 (Statistics/Data Analysis). Furthermore, my data
will be collected from the Ameco database of Europa. The official equation of my
economic model will be linear, with my dependent variable being the budget deficit and
my ten independent variables being as follows: GDP, GDP growth rate, the output gap,
gross public debt, real long term interest rate, population ages 15-64 (unit 1000 & % of

12
total pop), population above 64 ( unit 1000 & % of total pop), gross fixed capital, and the
consumer price index ( inflation included). The linear equation of my model will be:
Net lending = GDP + GDP growth rate + output gap + gross public debt +
real interest rate + % of total pop ages 15-64 + % of total pop over 64 + gross fixed
capital + consumer price index (CPI) + inflation
In addition, at the end of my paper I will use an economic mapping software known as
ArcGIS to illustrate the magnitude of my independent variables on each of these 15
countries budget deficits during the year 2005. Thus, allowing me to see the changes in
budget expenditure after “SGP II” was implemented in June 2005 and the most realistic
conclusion to presume from my results on the future of the SGP in the EMU.
Results:
Table 1A: Results for all 15 Countries
Before 1993
Variable Mean Std. Dev. Coefficient Z-value
Sig.
Level
GDP 314.2177 364.7010 0.0133 1.79
pop 64 13.6557 1.6501 -0.9623 -0.91
pop15-64 65.5772 2.4780 0.9903 1.75
output gap -0.4119 2.4612 0.7750 3.81 **
capital 11.8303 12.1635 -0.1729 -0.67
debt 211.8247 250.1433 -0.0144 -2.24 *
interest rate 3.8500 3.1233 -0.3221 -1.39
inflation 7.9957 5.9505 0.1453 0.52
GDPpercent 10.6503 5.9766 -0.2679 -1.58
**.01significance level
*.05 significance level

13
Table 1B: Results for all 15 Countries
Conversion Period (1992-1998)
GDP 600.1434 606.0117 0.0088 4.88
pop 64 14.9908 1.4577 0.1054 0.32
pop 15-64 66.4070 1.8756 -0.3487 -2.01
output gap -1.4600 1.7785 0.7017 5.8
capital 16.0659 18.0216 -0.2958 -5.48
debt 316.4311 354.4607 -0.0052
interest rate 4.6600 1.7611 -0.2597
inflation 2.7611 2.1993 -0.6611
GDP percentage 5.9702 3.2011 -0.1199
Table 1C, Results for all 15 countries
EMU period ( 1999-2005)
Variable Mean Std. Dev. Coefficient Z-Value
Sign
Level
GDP 792.4564 755.3502 0.0032 1.59
Pop 64 15.6757 1.7668 -0.4385 -1.23
Pop 15-64 66.7413 1.4352 -0.5428 -1.38
output gap 0.5086 1.5571 0.5505 2.36 **
capital 19.6412 20.1367 -0.0993 -1.51
debt 393.4508 452.4016 -0.0034 -1.92 *
interest rate 2.4556 1.2784 0.3742 1.52
inflation 2.3171 0.9957 0.1282 0.45
GDP percentage 5.0940 2.7722 0.0288 0.18
**.01 significance level
Table 2A, Results for 12 EMU countries
Before 1993
Sign
Level
GDP 236.8210 326.5497 0.0122 1.83
pop 64 13.1404 1.3319 -1.0426 -1.85
pop 15-64 65.7062 2.6988 0.5994 2.07 *
output gap -0.3385 2.5271 0.8455 2.77 **
capital 12.0722 13.2853 -0.1536 -0.79
debt 217.6718 267.1923 -0.0145 -4.39 **
interest rate 3.7062 3.1720 0.0547 0.17
inflation 8.1178 6.4075 -0.0684 -0.25
GDP percentage 11.0127 6.4018 -0.3667 -1.6
** .01 significance level
* .05 significance level

14
Table 2B, Results for 12 EMU countries
Table 2C, Results for
12 EMU Countries
EMU Period (1999-
2005)
GDP 592.7776 655.7208 .0014244 .36
pop 64 15.60884 1.925493 -.6373377 -1.40
pop 15-64 67.03719 1.405323 -.1379856 -0.29
output gap .5797619 1.653822 .4675346 1.76
capital 15.01806 15.33471 -.0616955 -0.66
debt 418.4873 486.3157 -.001371 -.30
interest rate 2.341667 1.353321 .2310404 .83
inflation 2.409044 1.010589 .1999309 .62
GDP percent 5.251678 3.035236 .0434161 .25
**.01 significance level
Table 3A, Results for 3 non EMU
countries
Before 1993
Variable Mean Std. Dev. Coefficient Z-Value
GDP 623.8042 347.3542 NA NA
pop 64 15.7166 1.1023 NA NA
pop 15-64 65.0611 1.1342 NA NA
output gap -0.6979 2.1864 NA NA
capital 10.6888 3.5989 NA NA
debt 177.7165 116.0794 NA NA
interest rate 4.3833 2.9046 NA NA
inflation 7.3138 3.5650 NA NA
GDP % 9.2007 3.5257 NA NA
Conversion Period (1993-
1998)
GDP 454.264 549.7332 .0061351 1.41
pop 64 14.69658 1.408221 1.042413 2.27 *
pop 15-64 66.69158 1.854373 -.3671893 -2.03*
output gap -1.468056 1.765222 .6399053 5.28 **
capital 11.97319 13.92103 -.1597984 -1.59
debt 331.4315 382.2003 -.0065808 -1.59
interest rate 4.494444 1.829946 -.1233285 -1.30
inflation 2.91915 2.371502 -.626563 -4.97 **
GDP percentage 6.2542 3.393539 -.0782092 -0.87

15
Table 3, Results for 3 non EMU countries
Table3C: Conversion Period
(1993-1998)
Variable Mean Std.Dev. Coefficient Z-Value
GDP 1183.661 458.0973 0.006933 0.11
pop 64 16.16788 1.004042 6.832236 2.45 *
pop 15-64 65.26889 1.530293 2.722065 3.04 **
output gap -1.42777 1.882678 1.696276 3.23 **
capital 31.98222 23.20156 -0.11165 -1.05
debt 252.9 193.6882 0.0004841 0.08
interest rate 5.3222 1.292765 -1.075512 -2.96 **
inflation 2.129054 1.142252
-
0.4870625 -1.19
GDP % 4.834395 1.960176
-
0.6964256 -3.27 **
Table 3, Results for 3 non EMU
countries
EMU Period
(1999-2005)
Variable Mean Std.Dev. Coefficient Z-Value
GDP 1591.171 587.5388 0.0130483 1.55
pop 64 15.91802 1.011338 -3.968771 -1.19
pop 15-64 65.55754 0.821752 -4.250567 -2.16 *
output gap .2238095 1.072802 0.8607669 1.55
capital 38.13381 26.14975
-
0.2535472 -1.47
debt 293.3048 263.854
-
0.0027976 -0.31
interest rate 2.911111 0.794754 0.6443221 0.94
inflation 1.949459 0.859823 0.0640399 0.08
GDP % 4.46329 1.099483 0.1071675 0.24
** .01significancelevel

16
Empirical Analysis of Results:
After running numerous cross-sectional time series analysis on the budget deficit
in Stata my results illustrate the most significant factors influencing the budget deficit of
EU countries both within and without the EMU period. During the whole time interval of
my economic analysis, thus from 1978-2005, the most significant variables that affected
all 15 member states’ budget deficits were the output gap and the debt. The more
significant being the output gap, which had a positive coefficient sign. This meaning that
when the output gap increased by one unit it resulted in the budget deficit of each of these
countries to increase. Consequently when the potential GDP of countries was lower than
the actualized GDP it increased the budget deficit, thus resulting in increases in overall
debt.
However, when I ran regressions in Stata focusing particularly on the 12 EMU
member states I found that the output gap and the debt continued to be the most
significant variables affecting the budget deficits of these countries before the Treaty of
Maastricht and during conversion period in Europe (1978-1998). The signs of these
variables stayed the same, the output gap was positive and the debt was negative. Thus,
showing the correlation that the potential EMU countries continued to overestimate their
potential GDP in comparison to their actualized GDP, resulting in the debt to increase
over time. The problem with this analysis is the sign of the debt being negative. My
results might be flawed because of this sign, since debt is the accumulation of an
individual member state’s budget deficits over time. There seems to be a paradox of
sorts, due to the opposite signs of these values. According to the output gap playing a

17
more significant role throughout my regressions, I will have to favor this story to support
my conclusion later.
My results on the 12 EMU countries since the implementation of the Stability and
Growth Pact show that there are no predominant factors attributing to the budget deficits
of the euro zone countries during SGP I. The P values of all my independent variables
exceed the benchmarks of significance defined in my economic model.
Unfortunately, the Ameco database of Europa did not have enough information on
my three non EMU countries prior to 1993 to run regressions. Nonetheless, there were
numerous independent variables that significantly affected the budget deficits of the
U.K., Denmark and Sweden during the Conversion Period. They were the percentage of
the total population ages 15-64, the output gap, the interest rate, and the GDP growth
rate.
Ironically, the only significant factor shown through my regressions to
substiantially affect the budget deficits of these three non-EMU countries after the
implementation of the Stability and Growth Pact in 1999 was the percentage of the total
population ages 15-64.
Policy Implications/ Conclusions:
Overall, my regressions in Stata are ambiguous. However, when taking into
account all 15 countries examined throughout the Europeanization period, the conversion
period, and the EMU period in this paper, one can clearly see that the most significant
factor that needs to be addressed is the availability of quality statistics and economic
indicators to improve the forecasting of potential GDP by countries. This problem is
ubiquitous throughout the greater European Economic Community, and does not solely

18
single out EMU countries that have breached the fiscal deficit criterion of the Stability
and Growth Pact. As for the future of the newly revised “SGP II”, perhaps there are
more reasons to be optimistic when evaluating my regressions. This can be concluded
due to the fact that the significance of the output gap when calculating the budget deficits
of the euro zone countries has decreased ever since these countries transitioned into the
EMU. In essence, the SGP has forced national governments to practice fiscal discipline,
and make the necessary structural changes to reconcile the perpetual economic problems
of their domestic economies. All in all, my personal view on the future of the newly
revised “SGP II” is that the “preventive arm” of the pact allows for the necessary
structural changes that will promote long term economic sustainability in the EMU. If
countries can economically and politically dedicate themselves to the fiscal criterion of
“SGP II” and not take advantage of the pact’s discretionary rhetoric in the “excessive
deficit procedure” than the EMU will only become a stronger economic market.
However, I am still skeptical of EMU member states political commitment to the “SGP
II” based on past economic violations of the original SGP I. The key success to the “SGP
II” will be the ability of national governments and the European Council to continually
improve the economic indicators to forecasts individual member state’s budgetary
divergences from their “country specific” medium term objectives. If the strengthening
of the “preventive arm” of the new “SGP II” can decrease the significance of the output
gap from causing EMU countries from entering into the “excessive deficit procedure”
then the “SGP II” will eventually be a success. The process of lowering European debt
will be a long-term goal, but the “SGP II” helps foster the inevitable success of this goal
if the EMU member states are patient enough to see it through.

19
Bibliography
Buti, Marco, Eijffinger, Sylvester, and Daniele Franco, 2005, “The Stability Pact Pains:
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