Fiscal Policy and Macroeconomic Performance in the Euro Area: Lessons for the Future

Since the start of the Economic and Monetary Union (EMU) fiscal policy in the Euro Area has been dominated by the Stability and Growth Pact (SGP). However, the SGP has been unsuccessful in fulfilling both its goals, fiscal sustainability and supporting economic growth: In recent years, more and more countries have exceeded the 3 per cent of GDP limit for the budget deficit. At the same time, macroeconomic performance has been unsatisfactory, with the Euro Area economy only slowly recovering from the post-2000 stagnation. The prolonged stagnation as well as the ongoing fiscal problems have revived the macroeconomic debate on a reform of the SGP. A reform was finally introduced after a legal conflict between the European Commission and the European Council about the Council’s right to simply ignore the Commission’s recommendation to further pursue the ‘excessive deficit procedure’ (EDP) against France and Germany. However, the reform did not fundamentally change the SGP. Therefore, the economic and political debates on SGP reforms continue. In this chapter we would like to contribute to this debate. After a rather detailed account of fiscal policy developments and their impact on the Euro Area economy, we present a modified expenditure path concept as an alternative to the current SGP.