Stability and Growth Pact

Formula used to calculate the
*MTO Minimum Benchmark*
000000000000000000000000000000000000
MTO^MB = –3% – ε × ROG
ROG = ${\tfrac {Ni}{(Nt+Ni)}}$ ${\tfrac {Ni}{(Nt+Ni)}}$ × P_5% state + ${\tfrac {Nt}{(Nt+Ni)}}$ ${\tfrac {Nt}{(Nt+Ni)}}$ × P_5% EU27
ε stands for the country-specific semi‑elasticity of the government budget balance to output gap. Normally these figures are only recalculated every third year. However, after its latest recalculation in October 2012, the following 2014 revision by OECD of individual revenue and expenditure elasticities prompted the Commission to recalculate the semi‑elasticities again in November 2014. ROG stands for the Representative Output Gap, which gets recalculated every third year for the latest 25‑year period (last time Oct.2012, for the 1986‑2010 period). Based on the historic distribution of output gap data, the ROG figure attempts to identify the most negative output gap appearing across a full business cycle by a 95% likelihood. It is calculated by a formula comprising the following parameters: P_{5% state} represents the 5% percentile of the distribution of the country‑specific output gap series for the latest 25‑year period (1986‑2010). P_{5% EU27} represents the 5% percentile of the output gap data for all countries for the latest 25‑year period (1986‑2010). The above 5% percentiles are computed after outlier values are deleted. Outliers are defined as observations of the distribution for the entire sample – including all Member States – below and above, respectively the 2.5% and 97.5% percentiles. Exceptionally, it has also been decided to trim the country‑specific series of their most negative value achieved in either 2009 or 2010, as this last financial economic crisis cannot be considered as a normal cyclical fluctuation. N_i and N_t stand for the number of country‑specific and common annual observations available, respectively, over a period of 25 years. Meaning that N_t=25, while N_i can be lower for some states due to absence of available cyclically‑adjusted budget data for them in the earliest years. For states with N_i=25, the ROG is the simple average of the two percentiles: ROG = (P_{5% state} + P_{5% EU27})/2.

Formula for the *MTO limit due to Implicit Liabilities and Debt*
0
MTO^ILD = BB_stable debt + BB_{debt reduction} + BB_LTC
BB_{stable debt} = -(60×g_pot)/(1+g_pot)
BB_{debt reduction} = 0.024×D_t-1 - 1.24
BB_LTC = 0.33×S2_LTC
BB_{stable debt} stands for the Budget Balance in structural terms needed, so that a fictive 60% debt‑to‑GDP ratio at the beginning is kept stable throughout an infinite (50 year) time horizon - while solely taking the impact of nominal GDP growth into concern. BB_{debt reduction} stands for the Budget Balance in structural terms needed to conduct a supplementary debt reduction effort for countries whose debt exceeds 60% of GDP. The provided formula for debt reduction is not applied (BB_{debt reduction}=0) if the debt‑to‑GDP ratio was less than 60% by the end of the latest completed fiscal year. BB_LTC stands for a proportion (33%) of the Budget Balance adjustment needed to cover the present value of the future increase in age‑related expenditure (the cost of Long‑Term Care). g_pot stands for the country‑specific long‑term average potential growth rate for GDP in nominal terms, projected every third year by the Ageing Working Group as an average figure for the next 50 years (latest in Nov.2014, for 2013‑60). The referenced latest figures are given in real terms, and shall be adjusted to nominal terms before input in the formula, which is done for all countries by adding AWG's common inflation (GDP deflator) assumption for the period of 2.0%. D_t-1 stands for the general government's debt‑to‑GDP ratio (in gross terms) by the end of the latest completed fiscal year. S2_LTC represents the fiscal adjustment in structural balance terms being needed to finance the country's age‑related costs for Long‑Term Care throughout 2010‑2060, and gets recalculated every third year by the Commission's Fiscal Sustainability Report (latest in Oct.2012). The reason why the formula only include 33% of the S2_LTC as current and constant saving needs throughout the years (to lower the debt further or be put aside as reserve liquidity at public saving accounts to cover future increases for age‑related costs), is the assumption the state will find the remaining 67% of needed savings through later implementation of structural cost saving reforms.

The Stability and Growth Pact (SGP) is an agreement, among the 28 Member states of the European Union, to facilitate and maintain the stability of the Economic and Monetary Union (EMU). Based primarily on Articles 121 and 126 of the Treaty on the Functioning of the European Union, it consists of fiscal monitoring of members by the European Commission and the Council of Ministers, and the issuing of a yearly recommendation for policy actions to ensure a full compliance with the SGP also in the medium-term. If a Member State breaches the SGP's outlined maximum limit for government deficit and debt, the surveillance and request for corrective action will intensify through the declaration of an Excessive Deficit Procedure (EDP); and if these corrective actions continue to remain absent after multiple warnings, the Member State can ultimately be issued economic sanctions. The pact was outlined by a resolution and two council regulations in July 1997. The first regulation "on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies", known as the "preventive arm", entered into force 1 July 1998. The second regulation "on speeding up and clarifying the implementation of the excessive deficit procedure", known as the "dissuasive arm", entered into force 1 January 1999.

The purpose of the pact was to ensure that fiscal discipline would be maintained and enforced in the EMU. All EU member states are automatically members of both the EMU and the SGP, as this is defined by paragraphs in the EU Treaty itself. The fiscal discipline is ensured by the SGP by requiring each Member State, to implement a fiscal policy aiming for the country to stay within the limits on government deficit (3% of GDP) and debt (60% of GDP); and in case of having a debt level above 60% it should each year decline with a satisfactory pace towards a level below. As outlined by the "preventive arm" regulation, all EU member states are each year obliged to submit a SGP compliance report for the scrutiny and evaluation of the European Commission and the Council of Ministers, that will present the country's expected fiscal development for the current and subsequent three years. These reports are called "stability programmes" for eurozone Member States and "convergence programmes" for non-eurozone Member States, but despite having different titles they are identical in regards of the content. After the reform of the SGP in 2005, these programmes have also included the Medium-Term budgetary Objectives (MTO's), being individually calculated for each Member State as the medium-term sustainable average-limit for the country's structural deficit, and the Member State is also obliged to outline the measures it intends to implement to attain its MTO. If the EU Member State does not comply with both the deficit limit and the debt limit, a so-called "Excessive Deficit Procedure" (EDP) is initiated along with a deadline to comply, which basically includes and outlines an "adjustment path towards reaching the MTO". This procedure is outlined by the "dissuasive arm" regulation.

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