Limiting Central Government Budget
Deficits: International Experiences
James K. Jackson
Specialist in International Trade and Finance
January 31, 2011
Congressional Research Service
7-5700
www.crs.gov
R41122
CRS Report for Congress
P
repared for Members and Committees of Congress

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Limiting Central Government Budget Deficits: International Experiences

Summary
The global financial crisis and economic recession spurred national governments to boost fiscal
expenditures to stimulate economic growth and to provide capital injections to support their
financial sectors. Government measures included asset purchases, direct lending through national
treasuries, and government-backed guarantees for financial sector liabilities. The severity and
global nature of the economic recession raised the rate of unemployment, increased the cost of
stabilizing the financial sector, and limited the number of policy options that were available to
national leaders. In turn, the financial crisis negatively affected economic output and contributed
to the severity of the economic recession. As a result, the surge in fiscal spending, combined with
a loss of revenue, has caused government deficit spending to rise sharply when measured as a
share of gross domestic product (GDP) and increased the overall level of public debt. Recent
forecasts indicate that budget deficits on the whole likely will stabilize, but are not expected to
fall appreciably for some time.
The sharp rise in deficit spending is prompting policymakers to assess various strategies for
winding down their stimulus measures and to curtail capital injections without disrupting the
nascent economic recovery. The threat of sovereign defaults in Greece and Ireland, followed by
potential defaults in Italy, Portugal, and Spain, have prompted a broad range of governments in
Europe and elsewhere to develop plans to reduce the government’s budget deficit. This report
focuses on how major developed and emerging-market country governments, particularly the G-
20 and Organization for Economic Cooperation and Development (OECD) countries, limit their
fiscal deficits. Financial markets support government efforts to reduce deficit spending, because
they are concerned over the long-term impact of the budget deficits. At the same time, they are
concerned that the loss of spending will slow down the economic recovery and they doubt the
conviction of some governments to impose austere budgets in the face of public opposition.
Some central governments are examining such measures as budget rules, or fiscal consolidation,
as a way to trim spending and reduce the overall size of their central government debt. Budget
rules can be applied in a number of ways, including limiting central government budget deficits to
a determined percentage of GDP. To the extent that fiscal consolidation lowers the market rate of
interest, such efforts could improve a government’s budget position by lowering borrowing costs
and stimulating economic growth. Other strategies include authorizing independent public
institutions to spearhead fiscal consolidation efforts and developing medium-term budgetary
frameworks for fiscal planning. Fiscal consolidation efforts, however, generally require
policymakers to weigh the effects of various policy trade-offs, including the trade-off between
adopting stringent, but enforceable, rules-based programs, compared with more flexible, but less
effective, principles-based programs that offer policymakers some discretion in applying punitive
measures.

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Limiting Central Government Budget Deficits: International Experiences

Contents
Overview and Background .......................................................................................................... 1
Austerity Measures in Europe ..................................................................................................... 3
Impact on Central Government Budgets ...................................................................................... 4
Fiscal Consolidation: Country Efforts.......................................................................................... 8
Recent EU Austerity Measures .................................................................................................. 12
Budget Rules ............................................................................................................................ 15
Budget Rules in Europe: The Stability and Growth Pact ............................................................ 17
Conclusions .............................................................................................................................. 20

Tables
Table 1. Fiscal Balance and Government Debt of G-20 Countries ................................................ 2
Table 2. Overall Central Government Budget Balances, Automatic Stabilizers and
Discretionary Measures of G-20 Countries ............................................................................... 5
Table 3. Size and Timing of Fiscal Packages................................................................................ 6
Table 4. Fiscal Consolidation Efforts in Selected Developed Countries........................................ 9
Table 5. Tax and Spending Policies Adopted by Members of the European Union as Part
of Economic Austerity Programs ............................................................................................ 12
Table 6. Fiscal Rules Applied in Developed Countries ............................................................... 16

Contacts
Author Contact Information ...................................................................................................... 21

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Limiting Central Government Budget Deficits: International Experiences

Overview and Background
The International Monetary Fund (IMF) has indicated,1 that growing concerns over the fiscal
balances, or the annual budget balance, of the economically advanced G-202 countries continue to
pose a risk to economic recovery. Financial turmoil in Greece, Ireland, and in other European
countries has placed increased pressure on national governments to adopt austerity measures to
satisfy credit markets. At the same time, most advanced economies are navigating a fine line
between fiscal austerity on one hand, and maintaining public support programs to forestall a slip
back into recession on the other. Indeed, the IMF warned that renewed turbulence in the
sovereign debt market, or government bond market, could “trigger an adverse feedback loop” and
inflict “major damage on the recovery.”
The IMF has indicated that government fiscal balances weakened by 6 percentage points of GDP
between 2007 and 2009, rising from 1.9% to 7.9% of GDP. The largest impact on the fiscal
balances of the advanced G-20 countries was projected to occur in 2009 and 2010. In 2009, the
IMF estimated that fiscal deficits increased by 5% of GDP in 2009, another three-fourths of a
percent in 2010, and 1.25% in 2011. Also, the forecast projected that government debt, or the
accumulated amount of government deficits, among the advanced G-20 countries would rise on
average by 14.5% of GDP by the end of 2009, compared with 2007, as indicated in Table 1.3 This
forecast was considered by the IMF to represent the middle of the range of estimates, and it is
based on the assumption that the economic recovery continued at the pace experienced in mid-
2009.
In the same forecast, the annual budget deficits for the emerging G-20 countries were projected to
widen on average from a surplus of 0.2% of GDP in 2007 to a deficit of 3.2% of GDP in 2009,
while government debt was expected to remain at a constant share of GDP. For European
governments, the rise in government budget deficits and the increase in the total amount of
government debt is undermining their efforts to reduce the size of their annual central government
budget deficits. These estimates for the growth in government debt could change, depending on
the success governments have in liquidating at favorable prices the assets they acquired during
the financial crisis, the timing and strength of the economic recovery, and the extent of any
payout on official guarantees.
The magnitude and pervasive nature of the government deficits is unsettling international capital
markets. In general, public sector debts are rising relative to national gross domestic product
(GDP), the broadest measure of a nation’s economic output. The international markets also have
become increasingly wary of rising government deficits due to an increased perception of risk. In
particular, these perceived risks are viewed as being especially high in Europe where financial
institutions are exposed to economic troubles in Greece, Portugal, and Spain. According to the
Bank for International Settlements (BIS) the euro area banks hold more than 70% of the

1 World Economic Outlook, International Monetary Fund, October 2010.
2 Members of the G-20 are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy,
Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States, and
the European Union.
3 The State of Public Finances: Outlook and Medium-Term Policies After the 2008 Crisis, International Monetary
Fund, March 6, 2009.
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outstanding public sector debt of Greece.4 Furthermore, the uneven pace of the economic
recovery is adding to perceptions of risk.
Table 1. Fiscal Balance and Government Debt of G-20 Countries
(expressed as a percent of national GDP)

Fiscal Balance
Government Gross Debt
Country
2007 2008 2009 2010 2014 2007 2008 2009 2010 2014
Argentina
-2.3% -0.5% -3.6% -2.3% -0.4% 65.9% 49.2% 38.6% 33.7% 23.5%
Australia
1.6 1.7 1.8 1.7 1.7 8.9 8.1 7.9 7.2 4.2
Brazil
-2.2 -1.1 -1.3 -1.2 -0.6 67.7 65.4 64.7 62.9 54.1
Canada
1.4 0.5 -1.5 -1.9 2.1 64.2 60.8 63.0
62.6 46.5
China
0.9 -0.1 -2.0 -2.0 -0.5 20.2 17.9 22.2 23.4 18.6
France
-2.7 -3.3 -5.5 -6.3 -2.7 63.9 66.1 72.3 77.1 79.4
Germany
-0.2 -0.1 -3.3 -4.6 0.1 65.0 68.7 76.1 80.1 77.2
India
-5.2 -7.8 -8.5 -7.4 -4.5 80.5 80.6 82.7 82.9 71.6
Indonesia -1.2 0.1 -2.6 -2.0 -1.6 35.0 32.5 31.8
31.3 28.3
Italy
-1.6 -2.7 -3.9 -4.3 -4.2 104.1 105.6 109.4
112.4 118.0
Japan
-3.4 -4.7 -7.1 -7.2 -6.4 195.5 202.5 217.0
225.1 222.3
Korea
3.8 1.4 -0.8 -0.8 0.6 32.1 32.8 32.9
33.0 29.3
Mexico
-1.4 -1.7 -2.9 -2.8 -2.3 38.3 39.3 42.1 42.5 42.0
Russia
6.8
5.3
-2.6
-2.0 -3.5 7.3 5.8 6.5
6.5 6.4
Saudi
15.8
35.0 -1.2 1.7 2.6 18.7 12.9 11.6 9.7 5.8
Arabia
South
0.9 -0.2 -1.9 -1.7 -0.3 28.5 27.2 27.0 26.7 22.2
Africa
Spain
2.2 -3.1 -6.1 -6.0 -2.1 36.2 38.6 48.6 53.8 56.3
Turkey
-2.3 -2.5 -2.3 -2.0 0.3 38.9 38.7 40.4 40.4 29.7
United
-2.7 -4.2 -7.2 -8.1 -4.8 44.0 50.4 61.0 68.7 76.2
Kingdom
United
-2.9 -6.4 -12.0 -8.9 -5.1 63.1 68.7 81.2 90.2 99.5
States
G-20
-1.1 -2.6 -6.2 -5.3 -3.0 63.5 65.5 72.5 76.7 76.8
Advanced
-1.9 -4.1 -7.9 -6.8 -3.8 78.8 83.2 93.2 99.8 103.5
G-20
Countries
Emerging
0.2 -0.1 -3.2 -2.8 NA 37.7 35.7 37.6 37.8 32.0
Market
G-20
Countries

4 BIS Quarterly Review, The Bank for International Settlements, March 2010, p.1.
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Source: The State of Pubic Finances: Outlook and Medium-Term Policies After the 2008 Crash, the International
Monetary Fund, March 6, 2009, Table 6.
Generally, the rising level of public sector debts in most countries does not reflect profligate
spending, but reflects measures policymakers adopted to avert a more serious and protracted
economic recession. Nevertheless, policymakers and financial markets are especially concerned
over the situation in Europe, where some investors view the rising deficits in Portugal, Spain,
Greece, and Ireland as increasing the risks for a default and the potential for additional turmoil in
the financial markets.5 In some cases, these countries have borrowed heavily from the European
Central Bank (ECB). The ECB requires borrower countries to provide government bonds rated
above BBB- as collateral, but that minimum rating was expected to rise to A- by the end of the
2010 and would rule out Greek bonds if rating agencies continue to downgrade the sovereign
bonds.
Austerity Measures in Europe
Concerns in credit markets and among policymakers over economic conditions in Europe,
particularly the economic conditions of Portugal, Greece, Spain, and Ireland, drove the topic to
the top of the agenda at the early February 2010 meeting of G7 finance ministers. In addition, the
exchange value of the euro depreciated against the dollar in late 2010 amid broader concerns over
the impact budget deficits are having on the larger economies in the Eurozone.6 Such concerns
could tighten credit and raise borrowing costs for a broad number of countries. Rather than
relying on the International Monetary Fund to provide loans to the four countries in the most
immediate danger, the richer economies of the Eurozone, particularly France and Germany, have
stepped in and provided loans and other assistance to those nations in trouble. Prospects of a
default by any member of the Eurozone, however, could severely strain the cohesion of the zone
and challenge some aspects of European economic integration.
The potential for insolvency in Greece, Ireland, Portugal, and Spain has increased concerns
among EU members over the impact the financial crisis and the economic recession are having on
the future of the Eurozone. In addition, the continuing financial and economic weaknesses are
buffeting the economies of Central and Eastern Europe and raising concerns regarding the
prospects for political instability7 and future prospects for market reforms. Moreover, the pace of
economic recovery in Central and East European countries is compounding the current problems
facing financial institutions in EU member states, since many of them are financially exposed in
Central and Eastern Europe. Mutual necessity helped EU members agree to support a generally
unified position to increase aid to Central and East European economies and to Greece. In May
2010, European leaders and institutions adopted a package of emergency measures to stem rising
financial market tensions associated with concerns over the fiscal solvency of Greece and several
other Eurozone countries. In coordination with the International Monetary Fund (IMF), Eurozone
members announced a three-year, 110 billion Euro (about $145 billion) financial assistance
program for Greece, a 60 billion Euro ($78 billion) European Financial Stabilization Mechanism

5 Faiola, Anthony, Debt Concerns Weigh on Europe, The Washington Post, February 6, 2010, p. A1.
6 The sixteen members of the Eurozone are: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland,
Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.
7 Pan, Phillip P., Economic Crisis Fuels Unrest in E. Europe, The Washington Post, January 26, 2009, p, A1.
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(EFSM), and a 440 billion Euro (about $580 billion) European Financial Stability Facility
(EFSF).
The EFSM is a new supranational EU balance of payments loan facility available from the
European Commission to any EU member country facing financial difficulties. The facility is
similar in design to an existing 50 billion Euro ($65 billion) EU balance of payments facility that
can only be drawn on by non-Eurozone EU member nations.8 Since 2008, Hungary, Latvia, and
Romania have borrowed from this later facility as part of a joint EU-IMF economic adjustment
program. Under the new EFSM, the borrowing nation would be subject to economic austerity
measures that would be supervised by the European Commission, which would decide at regular
intervals whether sufficient fiscal progress has been made to warrant the continued release of
funds. The funds are available immediately and there is no sunset date for the EFSM. To date, no
country has requested funds from the EFSM.
On November 21, 2010, Irish officials reversed policies and asked the EU and the IMF for
financial assistance to avert a financial crisis. The loans and stand-by credits are expected to be
provided through the EFSM and the EFSF and could amount to 85-90 billion Euros, or about
$110-$120 billion, spread over three years, with the possibility of supplemental funds provided by
Britain and some other countries. Ireland is set to restructure some of its banks and to nationalize
others to stem the outflow of deposits that has drained Irish banks. Irish authorities had earlier
adopted income tax cuts and cuts in public sector pay and social welfare benefits to reduce the
government’s deficits. On November 24, 2010, Ireland’s Prime Minister, Brian Cowen,
announced a four-year $20 billion plan to reduce Ireland’s government debt. The plan reportedly
includes cuts of thousands of public sector jobs, phased-in increases in Ireland's value-added tax
(VAT) rate starting in 2013, and social welfare savings of $3.7 billion by 2014, but does not touch
the country's ultra-low corporate tax rate. News of the government’s call for financial assistance
has fractured the current coalition government and sparked public protests. The Irish crisis has
rattled international investors who have been dumping Spanish and Portuguese bonds in panic
selling, raising the prospects that one or both countries may need financial assistance.
Impact on Central Government Budgets
The current financial and economic crises have worsened the financial position of the central
government budgets of the G-20 countries, although the impact of the crises has varied by
country. The two crises are affecting the balance sheets of the central governments in three broad
areas. First, governments adopted a broad range of special measures to support the financial
system. Second, policymakers adopted discretionary fiscal stimulus measures to spur economic
growth in order to stem the effects of the sharp drop in economic activity. Third, most economies
experienced a loss in tax revenue and a surge in non-discretionary spending, referred to as
automatic stabilizers, including such activities as unemployment insurance, that rise without
direct legislative authorization. As a result of these factors, the financial crisis has undermined the
effectiveness of budget rules as government budgets are affected by large or prolonged internal or
external shocks.

8 The current balance of payments facility was created under Article 143 of the Lisbon Treaty, which limits assistance
to “member states with a derogation,” i.e., to those outside the Eurozone.
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Table 2 displays the combination of these three spending activities on the overall balance of G-20
countries. The data indicate that over the 2009-2010 period, the overall fiscal balance for the
United States is expected to fall from -5.9% to -8.9% of GDP as automatic stabilizers kick in and
as discretionary policy actions, in the form of deficit spending, increase. Additionally, the data
indicate that the U.S. budget balance is being affected almost equally by automatic stabilizers,
discretionary fiscal policy actions, and by other actions, including extraordinary measures, that
were taken to shore up the financial sector. In comparison, Saudi Arabia and Russia experienced a
double-digit deterioration in their budget balances as their government budgets shifted from
running a surplus to being in deficit, due in large part to the drop in oil revenues as the price of oil
fell during the economic recession. Saudi Arabia also adopted other discretionary fiscal measures
that contributed to its budget deficit. Great Britain, as is the case with other G-20 members,
adopted discretionary spending measures. Those measures, however, were less a factor in driving
up its budget deficits than spending associated with automatic stabilizers.
Table 2. Overall Central Government Budget Balances, Automatic Stabilizers and
Discretionary Measures of G-20 Countries
(as a percent of GDP)

Overall Balance
Average Annual Change in 2008-2010 compared
to 2007

Overall
Automatic Discretionary
2007 2008 2009
2010
Other
Balance
Stabilizers
Measures
Argentina
-2.3 -0.5 -3.6 -2.3 0.2 -0.6 -0.4
1.2
Australia
1.6 0.1 -2.2 -2.8 -3.3 -1.7 -1.5
0.0
Brazil
-2.2 -1.5 -1.0 -0.8 1.1 -0.7 -0.2
2.0
Canada
1.4 0.4 -3.2 -3.7 -3.6 -1.8 -0.9
-0.9
China
0.9 -0.3
-3.6
-3.6 -3.4 -0.6 -2.1 -0.7
France
-2.7 -3.1
-6.0
-6.2 -2.5 -2.4 -0.4 0.3
Germany
-0.2 -0.1
-4.0
-5.2 -3.0 -1.6 -1.1 -0.2
India
-5.2 -8.4 -10
-8.6 -3.8 -0.4 -0.4 -3.0
Indonesia
-1.2 0.1 -2.5 -2.1 -0.3 -0.1 -0.6
0.5
Italy
-1.5 -2.7
-4.8
-5.2 -2.7 -2.6 -0.1 0.0
Japan
-3.4 -5.0
-8.1
-8.3 -3.7 -2.2 -0.7 -0.9
Korea
3.8 1.2 -2.2 -3.2 -5.1 -1.5 -1.6
-2.1
Mexico
-1.4 -1.9
-3.2
-2.9 -1.3 -1.3 -0.5 0.6
Russia
6.8 4.2 -5.2 -5.1 -8.8 -1.4 -1.3
-6.1
Saudi
Arabia 15.8 35.5 -8.3 -6.5 -8.9 -0.5 -3.1
-5.4
South
Africa 0.9 -0.1
-2.7
-3.4 -3.0 -0.6 -1.0 -1.5
Turkey
-2.1 -3.0 -4.2 -3.3 -1.4 -2.1 0.0
0.7
United
-2.7 -5.5
-9.5
-11.0 -6.0 -2.5 -0.5 -2.9
Kingdom
United
States -2.9 -5.9
-7.7
-8.9 -4.6 -1.6 -1.6 -1.4
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Average Annual Change in 2008-2010 compared

Overall Balance
to 2007

Overall
Automatic Discretionary
2007 2008 2009
2010
Other
Balance
Stabilizers
Measures
G-20 PPP
-1.1 -2.6
-5.9
-6.3 -3.8 -1.4 -1.2 -1.2
GDP-
weighted
average
Memorandum
-1.6 -2.7
-6.0
-6.9 -3.5 -2.2 -0.6 -0.7
item: EU
G-20
Source: Global Economic Policies and Prospects, IMF Staff Note for the Group of Twenty Meeting, March 13-14,
2009, the International Monetary Fund.
Notes: PPP stands for purchasing power parity, or the data have been adjusted to account for exchange rates.
The three spending areas are: (1) automatic stabilizers, or those governments payments that are ratcheted up
automatical y as the rate of economic growth slows (unemployment insurance, for instance); (2) discretionary
measures, or macroeconomic policy actions that were taken specifically to address the economic downturn; (3)
other expenditures, such as fiscal expenditures to shore up distressed banks; and (4) the overal balance, or the
combination of the three effects. Negative numbers indicate deficit spending as a percent of GDP.
The OECD also has estimated the impact of spending increases and the loss of tax revenue on the
budget balances of major economies that are associated with the fiscal stimulus packages that the
developed economies adopted, as indicated in Table 3. On average, a decrease in tax revenue and
an increase in spending due to the stimulus packages adopted by the developed countries in 2008
to counter the economic recession and the financial crisis are expected to have a relatively equal
impact on the budget balances of the developed countries. For the United States, the loss in tax
revenue is expected to have a larger negative impact on the budget balance than the negative
effect associated with a higher level of spending. The OECD estimates indicate that the economic
recovery that began in 2009 will stem the continued deterioration in budget balances in 2010, but
that it likely will not be a strong enough recovery to turn around the budget balances in most of
the larger economies.
Table 3. Size and Timing of Fiscal Packages
(Change in central government budget balances by component and period)
2008-2010 net effect on fiscal

balance
Distribution over the period
Spending
Tax
Total 2008 2009 2010
revenue

Percent of 2008 GDP
Percent of total net effect
Australia -4.1% -1.3% -5.4% 13.0% 54.0% 33.0%
Austria
-0.4 -0.8 -1.2 0.0 79.0 21.0
Belgium
-1.1 -0.3 -1.4 0.0 51.0 49.0
Canada
-1.7 -2.4 -4.1
12.0 41.0 47.0
Czech
-0.3 -2.5 -2.8 0.0 56.0 44.0
Republic
Denmark -2.6 -0.7 -3.3 0.0 33.0 67.0
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2008-2010 net effect on fiscal

balance
Distribution over the period
Spending
Tax
Total 2008 2009 2010
revenue

Percent of 2008 GDP
Percent of total net effect
Finland
-0.5 -2.7 -3.2 0.0 47.0 53.0
France
-0.6 -0.2 -0.7 0.0 68.0 32.0
Germany -1.6 -1.6 -3.2 0.0 48.0 52.0
Greece
0.0 0.8 0.8 0.0 100.0
NA
Hungary
7.5 0.2 7.7 0.0 51.0 49.0
Iceland
1.6 5.7 7.3 0.0 28.0 72.0
Ireland
2.2 6.0 8.3 6.0 39.0 55.0
Italy
-0.3 0.3 0 0.0 15.0 85.0
Japan
-4.2 -0.5 -4.7 2.0 74.0 25.0
Korea
-3.2 -2.8 -6.1
17.0 62.0 21.0
Luxembourg -1.6 -2.3 -3.9 0.0 65.0 35.0
Mexico
-1.2 -0.4 -1.6 0.0 100.0 NA
Netherlands -0.9 -1.6 -2.5 0.0 49.0 51.0
New
0.3 -4.1 -3.7 6.0 54.0 40.0
Zealand
Norway
-0.9 -0.3 -1.2 0.0 100.0 NA
Poland
-0.8 -0.4 -1.2 0.0 70.0 30.0
Portugal ..
.
-0.8
0.0
100.0
0.0
Slovak
-0.7 -0.7 -1.3 0.0 41.0 59.0
Republic
Spain
-2.2 -1.7 -3.9
32.0 44.0 23.0
Sweden
-1.7 -1.7 -3.3 0.0 43.0 57.0
Switzerland -0.3 -0.2 -0.5 0.0 68.0 32.0
Turkey
-2.9 -1.5 -4.4
17.0 46.0 37.0
United
-0.4 -1.5 -1.9 11.0 85.0 4.0
Kingdom
United
-2.4 -3.2 -5.6
21.0 37.0 42.0
States
Major
seven -2.1 -2 -4.1
15.0 47.0 38.0
OECD
-0.9 -0.9 -1.7
12.0 60.0 28.0
average
Source: Official Packages Across OECD Countries: Overview and Country Details, Organization for Economic
Cooperation and Development, March 31, 2009.
This continued erosion in budget balances through 2010 has raised concerns among some
policymakers who contend that the budget deficits are undermining market confidence in their
governments. As a result of these concerns, some analysts argue that capital markets could grow
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reluctant to finance the budget deficits without greater compensation in the form of higher
returns, which would add to the overall cost of the deficits. In a recent report, however, the IMF
concluded that a rise in the level of the central government’s debt, by itself, does not necessarily
have a major adverse impact on a government’s solvency and, therefore, on financial markets.
Nevertheless, the IMF cautions that the rise in government debt represents an important challenge
that should not be ignored. The IMF contends that the source of the rise in government debt is a
factor in market confidence.
According to the IMF, the current rise in government deficits for most countries does not
represent an explosive upward path in spending, but represents targeted and necessary policy
responses to the financial and economic crises. A rise in government debt that is directed at
stemming an economic recession or a financial crisis does not necessarily undermine market
confidence as long as governments can undertake credible programs to reduce spending once the
crisis has been averted. With some notable exceptions such as Greece, the rise in spending
generally is not viewed as representing profligate spending by central governments, but is
attributed to measures to address the financial crisis, including spending on social programs that
rise without overt discretionary actions. Such automatic stabilizers have an especially large
impact on the spending of governments within the European Union, where the government sector
accounts for a larger share of total GDP.
Fiscal Consolidation: Country Efforts
Since 1990, numerous national governments in developed countries have undertaken fiscal
consolidation efforts, often by adopting a budgetary rule that restricts the size of the annual
amount of the government budget deficit to a certain percentage of GDP. The reasons for fiscal
consolidations are as varied as the governments themselves. Most often, policymakers are
motivated to reduce the government’s budget deficit due to a variety of concerns. These include:
the rising pressure on public finances of aging populations; the cost of financing a rising amount
of debt; the impact on price inflation; the crowding out of private investment; and the reputation
and credibility of the government and its economic policies in the financial markets. Table 4
details fourteen instances between 1990 and 2005 identified by the IMF in which governments in
developed countries undertook fiscal consolidation. As is indicated, these efforts generally were
initiated for a short period of time and were designed to meet a specific objective. The details
provided by the IMF include the political and macroeconomic environment in which the fiscal
consolidation occurred and the condition of the central governments’ budget. In a number of
cases, budget consolidation can be associated with a change in governments in which the budget
deficit was an issue in the preceding election.
The IMF concluded that successful fiscal consolidation efforts generally were accompanied by a
supportive domestic and international environment, including, but not limited to, periods of
sustained positive economic growth among trading partners. While fiscal consolidation generally
tends to reduce the overall rate of growth in an economy in the short run due to the drop in the
central government’s contribution to GDP growth, the IMF authors concluded that: (1) this
negative effect was not as pronounced as had been indicated in previous studies; (2) that in some
cases fiscal consolidation had a positive impact on the rate of economic growth; and (3) that the
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long-term impact on economic growth from a reduction in central government spending depended
on a range of factors, including the strength of private domestic demand.9
To reduce the size of the government’s deficit spending, policymakers have a number of options.
These options include reducing current spending, increasing current revenue, reducing capital
spending, or some combination of spending reductions and revenue increases. While the record
on the economic effects of these various approaches to fiscal consolidation is mixed, a study by
the OECD concluded that “spending restraint (notably with respect to government consumption
and transfers) is more likely to generate lasting fiscal consolidation and better economic
performance” than revenue enhancements.10 Despite this general result, the OECD study also
concluded that the experiences of OECD countries was that revenue increases “accounted for a
larger fraction of the total reduction,”11 than did reductions in government spending. In addition,
the study concluded that three-fourths of the episodes involved a combination of cuts in
government expenditures and increases in government revenues. Reductions in capital spending
generally played a small role in such fiscal consolidation efforts, according to the OECD study.
Table 4. Fiscal Consolidation Efforts in Selected Developed Countries
Macroeconomic
Episode
Political Background
Background
Government Finances
Canada, 1994–97 Majority federal government Recovery from recession;
Sizable deficit and debt stock;
elected in 1993 to address
low inflation; high output gap
large share of debt held at short
fiscal issues; similar election
and unemployment; exchange term and by nonresidents; high
result in 1994-95 in the two
rate deprecation; improving
tax-to-GDP ratio; expending
largest provinces.
current account balance.
entitlements; sub-federal fiscal
issues.
Denmark, 2004–
The ruling center-right
Continued economic
A moderate level of public debt
05
coalition entered the
slowdown (since 2001)
(of about 50% of GDP), a near-
second half of its term with
characterized by gradually
balanced budget.
a diminishing voter support.
rising unemployment.
Finland, 1998
Both the coalition elected in Gradual consolidation (from
High deficit and medium-level
1991 and the grand coalition 1992) started at the time of
but rapidly increasing debt, high
elected in 1995 had a clear
deep recession characterized
tax-to-GDP ratio and expanding
mandate for EMU
by high output gap, rising
entitlement programs.
membership.
unemployment, low inflation,
and depreciating exchange
rate. By 1998 the economy
had recovered and enjoyed a
growth rate wel above the
EU average.

9 Kumar, Manmohan S., Daniel Leigh, and Alexander Plekhanov, Fiscal Adjustments: Determinants and
Macroeconomic Consequences, International Monetary Fund, IMF Working Paper WP/07/178, July 1007, p. 22.
10 Guichard, Stephanie, Mike Kennedy, Echkard Wursel, and Christophe Andre, What Promotes Fiscal Consolidation:
OECD Country Experiences, the Organization for Economic Cooperation and Development, Working Paper No. 553,
May 28, 2007, p. 7.
11 Ibid., p. 10.
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Macroeconomic
Episode
Political Background
Background
Government Finances
France, 1996–97 The president brought
The consolidation was
The expansionary policy in
forward parliamentary
launched against the
response to the 1993 recession
elections by one year to
background of a slow
left France with a large fiscal
ensure that the new
recovery from a recession,
deficit and a medium-level but
government had a clear
characterized by relatively
rapidly rising public debt, falling
mandate for fiscal
high unemployment, low
short of the EMU criteria.
consolidation and that
inflation, and exchange rate
domestic elections did not
depreciation.
interfere with the pre-EMU
meeting of the European
Council in early 1998.
Germany, 2003–
The coalition led by the
Three years of static output,
Fiscal deficit widened to about
05
Social-Democratic Party
high unemployment,
3.7% of GDP in 2002, with
narrowly won the elections
concerns about possible
public debt hovering around
in September 2002. The
deflation, heavy losses in the
60% of GDP.
comprehensive reform plan
financial sector.
(Agenda 2010) was unveiled
in March 2003.
Ireland, 2003–04 The coalition government
After a decade of strong
Relatively low level of public
enjoyed a strong
growth, economic activity
debt (below 35% of GDP), a
parliamentary majority since (excluding profits of
near-balanced budget, a
2002. In addition, there
multinationals) decelerated
relatively low tax-to-GDP ratio.
were few differences of
markedly in 2002 and
views within the coalition.
remained subdued in 2003.
Italy, 1997
The consolidation was
The consolidation attempt
Very high debt (of over 115%
preceded by the electoral
was launched during the time
of GDP in 1997), rising in spite
reforms at both the central
when growth turned negative of fiscal consolidation attempts
and regional levels, which
in late 1996 - early 1997 after since early 1990s.
resulted in more stable
strong performance in 1995,
governments with longer
and the return of the
political horizons.
recession of the early 1990s
was perceived as likely.
Inflation was declining but the
unemployment remained
high.
Japan, 2004
Ruling coalition since 2000.
Gradual economic recovery
A decade of high fiscal deficits
In 2004, the positions of the since mid-2002, with
(about 8 percent of GDP in
ruling party in both houses
contributions from both
2003) led to a rapid
of parliament shrank as the
exports and domestic
accumulation of public debt,
government's approval
demand, characterized by
which reached 160% of GDP.
rating hit the low of 36
gradually declining
The revenue-to-GDP ratio
percent (compared to 70–
unemployment and easing of
remained below 30%, while
90% in 2001), partly due to
deflation.
social security outlays kept
the passage of pension
rising.
reforms.
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Macroeconomic
Episode
Political Background
Background
Government Finances
Netherlands,
As a result of early elections There had been a significant
There had been a sharp
2004–05
in January 2003, center-right downturn in activity since
deterioration in the fiscal
coalition government took
2000. During the two years,
position with the 3 percent
office.
growth averaged barely 0.2%,
Maastricht deficit ceiling
with unemployment rising.
breached in 2003. The general
Activity began to pick up in
government balance worsened
2004 and growth was
by almost 5½ percentage points
projected at about 1% in
during the first three years of
2004 and 1¾% in 2005. The
the decade, as a result of the
authorities had the challenge
2001 tax reform, increases in
of nurturing the emerging
health care and education
recovery while ensuring fiscal
spending, and a higher deficit of
sustainability.
local governments (reaching 0.6
percent of GDP).
New Zealand,
Competitive political
Solid and accelerating
A slight budget surplus and a
2003
environment, with the
economic growth, narrowing
moderate level of public debt
opposition calling on the
current account deficit,
(of about 40% of GDP), which
ruling Labor Party to
unemployment at a 16-year
exceeded, however, the
introduce more tax cuts and low.
government's long-term target
improve the quality of
of 30% of GDP.
health and education
services. However, the
September 2005 elections
did not lead to any
significant relaxation of fiscal
policy and the incumbent
party was re-elected with a
confirmed mandate for
continued fiscal
consolidation.
Spain, 1996–97
Elected in March 1996, the
A relatively rapid economic
Public finances have gradual y
coalition government had a
recovery after the recession
deteriorated since 1988 with
mandate for fiscal
that culminated in a negative
annual fiscal deficits exceeding
consolidation.
growth in 1993. While
7% of GDP in 1995. Public debt
economic activity was on the
has rapidly risen to over 70% of
rise and inflation gradually
GDP.
subsided, high unemployment
(at above 20% of labor force)
proved to be persistent.
Sweden, 1994–
The Social Democrat
The deepest recession since
Fiscal deficit exploded to over
98
minority government
the 1930s, accompanied by
12% of GDP as a result of the
launched fiscal consolidation high inflation, quickly rising
cyclical downturn and the
following the 1994 general
unemployment, exchange
underfinanced tax reform of
elections.
rate depreciation and
1990–91, with public debt
associated improvement in
reaching 80% of GDP.
the current account balance.
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Macroeconomic
Episode
Political Background
Background
Government Finances
United Kingdom,
The popularity of the
Three successive years of
Public sector fiscal deficit
1995–98
conservative party by the
solid economic growth, led
increased to over 7 percent of
middle of the term was low. by private consumption.
GDP by 1994, the debt-to-GDP
After 18 years of being in
Unemployment was falling
ratio was on the rise and
opposition, the Labor Party
rapidly, while inflation
already exceeded the target
won elections in May 1997
remained relatively low.
level of 40% by about 8
with an overwhelming
percentage points.
majority in Parliament. The
new government confirmed
the course of fiscal
consolidation and
introduced a number of new
policy reforms, including
transferring the
responsibility for setting
interest rates from the
Treasury to the Bank of
England.
United States,
New Democratic President
Economic activity had been
The federal government fiscal
1994
took over in January 1993.
weak for some time, and
situation had been deteriorating
The Congress was also
unemployment was rising.
at a sharp pace. The deficit was
Democratic and there was
almost 5% of GDP. In nominal
expectation of an initiative
terms federal debt had
to reduce debt.
quadrupled over 1980–92 and
the debt ratio was projected to
continue rising at a high rate.
Source: Kumar, Manmohan S., Daniel Leigh, and Alexander Plekhanov, Fiscal Adjustments: Determinants and
Macroeconomic Consequences, International Monetary Fund, IMF Working Paper WP/07/178, July 1007, p. 10-11.
Recent EU Austerity Measures
As Table 5 indicates, EU member countries have adopted various tax and spending measures to
reduce the size of their government budget deficit, many of which were exacerbated by the
economic recession and stimulus measures adopted during the 2008-2009 financial crisis to stem
the impact of the economic recession. The lingering effects of the recession are compounding the
problems of EU members, because most members have large automatic stabilizers, or public
support measures that are activated by economic events. Such measures include unemployment
benefits and other types of social welfare spending. In many cases, governments have chosen to
reduce public sector jobs or to freeze wages, because such changes usually can be adopted
without legislative action. Other governments have chosen to increase the value added tax (VAT),
or the tax that is applied through the various stages of production. Such taxes are less visible to
consumers, because the tax is incorporated into the final cost to consumers.
Table 5. Tax and Spending Policies Adopted by Members of the European Union as
Part of Economic Austerity Programs
Country Tax
Policies Spending
Policies
Austria
Increase taxes on banks, tobacco,
Undetermined cuts in spending.
gas, airline tickets.
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Country Tax
Policies Spending
Policies
Belgium
Proposals include tax increases on
Proposal to bar increases in health-care
pensions, taxes on CO2 emissions,
spending.
and a “crisis” tax on banks.
Bulgaria

Reduce spending by al government
ministries;
Reduce public sector jobs by 10%; freeze
public sector wages for three years.
Cyprus
Increase fuel taxes and corporate
A hiring freeze placed on civil servant
taxes by 1%. Considering an
jobs.
increase in VAT.
Czech Republic
Apply taxes on pensions of high
Reduce public sector wages by up to 43%.
earners.
Denmark

Cut unemployment benefits from 4 years
to 2 years; cut public sector employment
by 20,000; reduce child benefits; cut
ministerial salaries by 5%; reduce subsidies
to universities.
Estonia
Considering an increase in VAT

taxes.
Finland
Adopted taxes on energy; new

excise taxes on sweets and soft
drinks; VAT tax will rise by 1%.
France
Target tax loopholes; adopt a 1%
Withdraw stimulus measures; raise
surtax on the highest wage earners.
retirement age from 60 to 62; raise tenure
to qualify for state pension from 41 to
41.5 years of service; raise age
requirement for ful pension from 65 to
67 years.
Germany
Increase taxes on nuclear power.
Reduce subsidies to parents; cut 10,000 to
15,000 public sector jobs; reduce welfare
spending; reduce number in military by
40,000.
Greece
Target tax evasion.
Raise pension age; public sector wages cut
by up to 25%; eliminate public sector
Raise VAT from 19% to 23%; raise
bonuses; freeze public sector salaries and
taxes on fuel, alcohol, and tobacco
pension payments for 3 years; raise
by 10%; raise property and gambling retirement age from 61.4 to 63.5.
taxes.
Hungary
Adopted a tax levy on financial
Lower wage ceilings for public sector
sector for 2010 and 2011; adopted
employees; reduce by 15% subsidies to
a temporary increase of VAT rate
political parties; reduce the number of
to 25%.
seats in parliament and local assemblies;
increase retirement age to 65; adopted a
two-year freeze in public sector pensions;
cuts in pay for prime minister, ministers
and state secretaries; 10% cut in sick pay;
suspending housing subsidy.
Ireland
Increase capital gains and capital
Cut public sector wages by 5%; cut 24,750
acquisition tax by 25%; increase
public sector jobs; cut public sector
cigarette tax; increase carbon tax;
investment projects; reduce social welfare
adopted a new water tax.
and child benefits; cut minimum wage by 1
euro per hour.
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Country Tax
Policies Spending
Policies
Italy
Target tax evaders; adopted a
Reduce spending by 1.6% of GDP
carbon tax.
including cutting salaries of public sector
workers; freeze new hiring; raise
retirement age by 6 months; cut pensions
for public sector workers; reduce
payments to regions and cities.
Latvia
Raise real estate taxes; raise the
Cut public sector wages by 30% to 50%;
VAT on products from 10% to 18%; closed hospitals and schools; cut pensions;
income tax increased from 23% to
unemployment benefits linked with
26%; VAT increased from 18% to
“forced” labor.
21%; raise taxes on cars and real
estate; adopted tax on natural gas.
Lithuania
Raise taxes on alcohol and
Freeze public sector wages for two years;
pharmaceuticals; raise corporate
public sector pensions cut by 11%; reduce
taxes by 5%.
parental leave benefits.
Luxembourg

Reduce spending on transportation and
education.
Malta

Focusing efforts on creating more jobs.
Netherlands
Increases in undetermined taxes.
Raise retirement age; cut military
personnel by 10,000; cut spending on
grants for university students, healthcare
subsidies, and art subsidies. Number of
parliamentarians to be cut, along with
number in civil service.
Poland
Increase VAT by 1%.
Tighten pension requirements; cut military
spending.
Portugal
Increase corporate and income
Wages of the highest paid public sector
taxes by 2% to 5%; increase in VAT
workers to be cut by 5%; reduce defense
of 1%.
spending by 40%; delayed completion of
high-speed rail links; cuts in social
programs; privatize certain enterprises.
Romania
Raise VAT by 5%.
Cut civil servant wages by 25%; cut
pensions by 15%; cut up to 125,000 public
sector jobs.
Slovakia
Increase the VAT by 1%; raise taxes Reduce salaries of government ministers
on alcohol and cigarettes.
and lawmakers by 10%; postpone public
sector investment projects; cut wages of
civil servants; reduce up to 20,000 civil
servant jobs.
Slovenia

Reduce bonuses for civil servants; cancel
cost of living increases for civil servants.
Spain
Raise tobacco tax by 28%; increase
Cut public sector pay by 5%; freeze pay at
income tax by 1% on high earners.
that level for 2011; freeze public sector
pensions; eliminate 13,000 public sector
jobs; reduce public sector investment;
raise income taxes on wealthier; cancel
cost of living adjustments for those on
pensions; subsidies to regions will be cut;
sell off 30% interest in national lottery and
national government holdings in airport
authority.
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Country Tax
Policies Spending
Policies
Sweden
No austerity measures

implemented.
United Kingdom
Increase the VAT from 17.5% to
Reduce budget for government
20%.
departments by an average of 19%; cut in
the Department of Culture of 24%; raise
the retirement age from 65 to 66;
eliminate 490,000 public sector jobs; cuts
in spending for universities; reduce long-
term unemployment benefits by 25%;
eliminate benefits to those not actively
seeking employment; reduce welfare
spending, including eliminating child
benefits for those making over a certain
income; reduce military spending by 8%;
reduce police spending by 4%
Source: Developed by CRS from publicly available sources.
Budget Rules
One approach developed countries have used to address government budget deficits has been to
adopt some type of a budget rule. A study by the OECD on fiscal consolidation concluded that
most developed countries have at some time adopted budget rules that restrict the amount of
deficit spending to a specified percent of GDP and that constrain the overall level of the central
government’s debt, as indicated in Table 6. .12 One common feature of these rules is that most of
them were applied for a relatively short period of time. In contrast, members of the European
Union (EU), which account for half of the total number of developed countries, have adopted
both short-term, country-specific budget rules, and long-term EU-wide budget rules.
In general, the OECD concluded after observing fiscal consolidation efforts among OECD
countries since 1990 that the more successful of these efforts combined rules to balance the
budget with requirements to reduce expenditures. The study argues that no one rule fits all
countries and all circumstances, but that successful programs of consolidation seem to have some
common features. These features include rules that are simple to manage, while incorporating
enough flexibility, or discretion, to respond to downturns in the business cycles. The OECD study
also observed that budget rules that rely on reducing expenditures generally have been more
successful. By focusing on expenditures, the rules were more successful because: (1) they were
not reliant on cyclically volatile revenues; (2) they were designed to let economic stabilizers work
during a downturn; and (3) they saved windfall gains during an upturn. The data in Table 6. also
indicate if the budget rules include provisions for dealing with windfall surpluses and a “Golden
Rule” provision. A golden rule provision requires that the central government’s current
expenditures match its current revenues, exclusive of capital investments.

12 Guichard, Stephanie, Mike Kennedy, Echkard Wursel, and Christophe Andre, What Promotes Fiscal Consolidation:
OECD Country Experiences, Organization for Economic Cooperation and Development, May 28, 2007.
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Table 6. Fiscal Rules Applied in Developed Countries


Characteristics of the set of rules






Country
Name and date
Budget
Expenditure
Rule to deal
Golden
target
target
with windfall
rule
revenues
Australia
Charter of Budget Honesty
yes no no
no
(1998)
Austria
Stability and Growth Pact (1997)
yes
no
no
no
Domestic
Stability
Pact (2000)




Belgium
Stability and Growth Pact (1997)
yes
no
yes
no

National budget rule (2000)




Canada
Debt repayment plan (1998)
yes
no
yes
no
Czech
Stability and Growth Pact (2004)
yes
yes
no
no
republic

Law on budgetary rules (2004)




Denmark
Medium term fiscal strategy
yes yes no
no
(1998)
Finland
Stability and Growth Pact (1997)
yes
yes
no
no

Spending limits (1991, revised in




1995 and 1998)
France
Stability and Growth Pact (1997)
yes
yes
Since 2006
no
Central
Government




Expenditure Ceiling (1998)
Germany
Stability and Growth Pact (1997)
yes
yes
no
yes
Domestic
Stability
Pact (2002)




Greece
Stability and Growth Pact (1997)
yes
no
no
no
Hungary
Stability and Growth Pact (2004)
yes
no
no
no
Ireland
Stability and Growth Pact (1997)
yes
no
no
no
Italy
Stability and Growth Pact (1997)
yes
yes
no
no

Nominal ceiling on expenditure




growth (2002)
Japan
Cabinet decision on the Medium
yes yes no
no
Term Fiscal Perspective (2002)
Luxembourg
Stability and Growth Pact (1997)
yes
no
no
no
Coalition
agreement
on



expenditure ceiling (1999, 2004)
Mexico
Budget and Fiscal Responsibility
yes no yes
no
Law (2006)
Netherlands
Stability and Growth Pact (1997)
yes
yes
yes
no
Coalition
agreement
on



multiyear expenditure targets
(1994, revised in 2003)
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Characteristics of the set of rules






Country
Name and date
Budget
Expenditure
Rule to deal
Golden
target
target
with windfall
rule
revenues
New Zealand
Fiscal Responsibility Act (1994)
yes
yes
no
no
Norway Fiscal
Stability
Guidelines (2001)
yes
no
yes
no
Poland
Stability and Growth Pact (2004)
yes
no
no
no

Act on Public Finance (1999)




Portugal
Stability and Growth Pact (1997)
yes
no
no
no
Slovak
Stability and Growth Pact (2004)
yes
no
no
no
Republic
Spain
Stability and Growth Pact (1997)
yes
no
no
no
Fiscal
Stability
Law (2004)




Sweden
Fiscal Budget Act (1996, revised
yes yes no
no
in 1999)
Switzerland
Debt containment rule (2001,
yes yes yes
no
but in force since 2003)
United
Code for Fiscal Stability (1998)
yes
no
no
yes
Kingdom
Source: Guichard, Stephanie, Mike Kennedy, Eckhard Wurzel, and Christophe Andre, What Promotes Fiscal
Consolidation: OECD Country Experiences, Organization for Economic Cooperation and Development
[EC/WKP(2007)13], 2007.
Notes: The Golden Rule generally restricts central governments from borrowing to fund current spending.
Borrowing to fund investments generally is exempted from the budget rules. Essentially, the rule attempts to
equate current spending with current revenues.
Budget Rules in Europe: The Stability and Growth
Pact
In contrast to the short-term, country-specific budget rules most OECD countries have adopted at
various times to address rising central government budget deficits, the members of the EU also
operate within the requirements of the Stability and Growth Pact, which was adopted in 1997. EU
members decided that, due to the disparate performance and composition of their economies, it
was necessary to adopt a fiscal rule in lieu of relying on market forces to coordinate their
economic policies. The Pact consists of preventive measures that include monitoring the fiscal
policies of the members by the European Commission and the European Council so that fiscal
discipline is maintained and enforced in the Economic and Monetary Union (EMU). The Pact
also includes corrective measures that provide for fines for countries that fail over a number of
years to meet the Pact’s requirements. The European Union comprises the largest single bloc of
countries that collectively have applied a long-term set of rules. These rules require the members
to apply corrective measures to reduce their annual budget deficits and to reduce the overall level
of their government debt if the annual deficits or the overall amount of debt exceed certain
prescribed percentages of GDP. Since the Stability and Growth Pact was adopted, however, it has
not always been applied consistently, which eventually led the EU to amend the Pact.
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The basic elements of the Stability and Growth Pact did not originate with the Pact itself, but
were part of the original Maastricht Treaty that served as the founding document for the present-
day EU. The budget rules are based on Articles 99 and 104 of the Treaty, and related decisions,
including the excessive deficit procedure protocol. Article 99 of the Treaty requires the members
to “regard their economic policies as a matter of common concern.” They also are required to
coordinate their economic policies in order to have “similar economic performance.” Article 104
requires EU members to “avoid excessive government deficits.” EU members are expected to
follow established guidelines regarding the ratio of the government deficit relative to GDP and
the ratio of government debt to gross domestic product. The Protocol on Excessive Deficit
Procedure established the specific guidelines that are applied under Article 104. Under this
protocol, EU members are expected to have an annual budget deficit no greater than 3% of GDP
at market prices and government debt no more than an amount equivalent to 60% of GDP. The
number of member states with a fiscal deficit above 3% of GDP increased from two in 2007 to
twenty in 2010.13
All of the members of the EU are expected to meet the requirement of the budget rules.
Nevertheless, the rules are of especial importance to the group of countries known as the euro
area, because the members have adopted the euro as their common currency. Typically, countries
have a set of economic policy tools available to them to manage their economies. These
macroeconomic policy tools generally include such monetary and fiscal policy measures as
control over the nation’s money supply, adjustments in tax rates, and control over government
spending. In addition, nations have tools to affect the international exchange value of their
currency. By adopting a common currency, however, the euro area countries ceded control of
their currency to the European Central Bank. Consequently, the euro area countries agreed that
the loss of the exchange rate tool meant that they would need to make greater efforts to control
their government spending and their government budgets in order to restrain inflationary
pressures and to promote similar economic performance among countries that have widely
disparate economies. As a result, the euro area countries adopted budget rules as a component of
their common policy approach.
As the Pact took effect in 1999, EU members began criticizing the rules-based approach of the
Pact for being too stringent and they questioned whether the rules could be enforced. In 2003, the
weaknesses of the Pact were exposed when the European Council voted not to apply the punitive
procedures under the Excessive Deficit Procedure to France and Germany, which had
experienced rising levels of government debt. Some EU members argued that the Pact focused
too heavily on the rules-based percentage guidelines associated with the Pact without regard for
the circumstances under which a government’s level of debt or its deficit spending may rise, for
instance as a result of a temporary increase in government spending to counter an economic
downturn.14
The EU experience with the Pact demonstrates the policy tradeoffs that generally are involved in
adopting such programs. In order to have a fiscal consolidation program be effective, the program
needs to have stringent rules and penalties for violating the rules. At the same time, the current
economic recession and financial crisis have demonstrated that policymakers need some
flexibility and discretion in implementing budget rules in order to adjust the policy mix and

13 Public Finances in the EMU 2009, p. 30.
14 Beetsma, Roel M.W.J., and Xavier Debrun, Implementing the Stability and Growth Pact: Enforcement and
Procedural Flexibility, IMF Working Paper WP/05/59, International Monetary Fund, March 2005.
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generally to respond to differences in economic conditions. A fiscal deficit during periods of
economic recession or very slow growth, for instance, likely would require a different policy
prescription than one that arises during periods of strong economic growth when revues would be
high and payments made through automatic stabilizers would be low.
In 2005, the EU members adopted a number of changes to the Stability and Growth Pact. These
changes shifted the enforcement of the Pact from a rules-based regime to one based more on a set
of principles with more latitude for discretion in enforcing the corrective requirements. In the area
of prevention, the modified Pact provides for each EU member to develop its own medium-term
objectives to bring its deficit spending and its debt level into compliance based on the unique
economic conditions of each member. The modified Pact also relaxes the annual deficit targets as
Members move their budget balances into compliance and the Pact factors in the effects of
cyclical economic activity.
The corrective measures also were modified in a number of important ways. The changes allow
Members to avoid the corrective measures if their annual fiscal deficit is above 3% of GDP if
they can demonstrate that the deficit is caused by “exceptional and temporary” circumstances. In
addition, members can argue that their budget deficit should be exempt from the penalties of the
Excessive Deficit Procedure if they can demonstrate that the deficit is the result of “other relevant
factors.” Among the other relevant factors that are listed as fiscal expenditures are: (1) officially
sponsored research and development; (2) European policy goals; (3) support for international
objectives; (4) capital expenditure programs; (5) pension reform; (6) fiscal consolidation
programs; and (7) high contributions to EU-wide initiatives.
In 2008 as the financial crisis was unfolding, EU members were asked to provide a fiscal stimulus
to their economies in ways that would comply with the Stability and Growth Pact. These efforts
were part of a $256 billion Economic Recovery Plan15 proposed by the European Commission to
fund cross-border projects, including investments in clean energy and upgraded
telecommunications infrastructure. In order to comply with the Stability and Growth Pact, the EU
asked its members to make their fiscal stimulus plans timely, temporary, and targeted, so they
would not have a permanent impact on tax rates or on spending commitments beyond that
necessary to counter the effects of the two crises. As a result, each EU member was asked to
contribute an amount equivalent to 1.5% of their GDP to boost consumer demand. In addition,
members were tasked to invest in such capital projects as energy efficient equipment in order to
create jobs and to save energy, invest in environmentally clean technologies to convert such
sectors as construction and automobiles to low-carbon sectors, and to invest in infrastructure and
communications. This plan also proposed official support measures to increase the rate of
employment and to focus investments on such high technology sectors as telecommunications
and environmentally safe technologies.
While many in Europe and elsewhere felt the fiscal expansion during the depth of the economic
recession was an appropriate response, the sovereign debt crises in Greece and Ireland
emphasized shortcomings of the Stability and Growth Pact. As a consequence, some members of
the European Commission have proposed changing the Pact to strengthen its provisions and to
broaden the scope to include non-fiscal economic imbalances that have been outside the scope of

15 A European Economic Recovery Plan: Communication From the Commission to the European Council, Commission
of the European Communities, COM(2008) 800 final, November 26, 2008. The full report is available at:
http://ec.europa.eu/commission_barroso/president/pdf/Comm_20081126.pdf
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surveillance under the Pact. The proposals would promote medium term budget targets to signal
budget imbalances at an earlier stage and numerical benchmarks would be adopted to gauge the
pace of debt reduction. The reinforced Pact also would monitor certain macroeconomic indicators
to flag imbalances that could undermine the European Economic and Monetary Union (EMU).
The proposal also calls for incentives and sanctions to enforce the economic surveillance that
would be applied either automatically or semi-automatically on a sliding scale depending on the
extent to which the corrective measures were adopted by EU members that were found to be not
in compliance with the Pact.
Conclusions
Financial markets and policymakers are growing increasingly concerned over the high level of
deficit spending and the growing amount of government debt among a large number of advanced
and developing economies. Unlike previous bouts with rising government deficits in developing
countries, most of the current increase in government spending does not reflect out of control
spending, but represents a calculated response to a severe economic downturn and a global
financial crisis. In general, the two crises have affected the balance sheets of the central
governments in three broad areas: (1) special fiscal measures to address the financial crisis; (2)
discretionary fiscal stimulus measures to spur economic growth; and (3) a surge in non-
discretionary spending and a loss of tax revenue. As a result of these factors, the financial crisis
has undermined the effectiveness of budget rules as government budgets are affected by large or
prolonged internal or external shocks. Most estimates indicate that such deficits will stabilize in
2010, but will not decline appreciably for some time after that. On balance, losses in tax revenue
and an increase in spending associated with fiscal stimulus measures to counter the economic
recession and the financial crisis are expected to have a relatively equal negative impact on the
budget balances of the developed countries.
One approach most developed countries have used to address government budget deficits has
been to adopt a budget rule. In general, most developed countries have at some time adopted
budget rules to restrict the amount of deficit spending to a specified percent of GDP and to
constrain the overall level of the central government’s debt. One common feature of these rules,
however, is that most of them were applied for a relatively short period of time. In contrast,
members of the EU have adopted both short-term, country-specific budget rules, and long-term
EU-wide budget rules. Academic studies seem to indicate that the more successful budget efforts
combined rules to balance the budget with requirements to reduce expenditures. In developing
such budget rules, policymakers are caught between designing rules that are enforceable, but
inflexible, versus rules that are flexible and responsive to discretion, but less enforceable.
For national policymakers, the rising budget deficits and nascent economic recovery present a
challenging policy mix. Various governments have budget rules in place to limit the budget
deficits, but the necessity of continuing to provide stimulus to their economies to keep the
recovery on track has put these budget rules on hold. For policymakers, the challenge is to
unwind the fiscal stimulus measures that were adopted to prop up the financial sector and boost
economic growth without short-circuiting the economic recovery. The strength of the economic
recovery will determine the extent to which these dual policy goals are in conflict. A faster pace
recovery will reduce the size of the government’s budget deficits, which should work to ease the
concerns of financial markets. Over the short-term, however, financial markets have displayed
increased weariness over the magnitude and the pervasive nature of the deficits, especially in
Europe. This could result in tighter credit and higher interest rates for all market participants.
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Investors are particularly concerned over the exploding government debts and public unrest in
Spain, Greece, Portugal, and Ireland. So far, the wealthier economies of Europe, particularly
France and Germany, have felt compelled to step in and provide financial assistance to the four
struggling economies as a necessary price for preserving the Eurozone. If the situation is
prolonged, it may well challenge the willingness of populations in Germany and France to
continue supporting financial transfers to other members of the Eurozone and possibly challenge
the goal of European economic integration.

Author Contact Information

James K. Jackson

Specialist in International Trade and Finance
jjackson@crs.loc.gov, 7-7751


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