1 Second, there could be situations where the no bail-out clause might not be entirely credible, given that serious budgetary deviations in one country could generate economic and financial instability across the EMU as a whole, which would end up compelling the latter to bail-out countries in difficulties. Such constraints required implementing additional common rules. Thus, the Treaty stipulated that Member States should avoid excessive deficits and that the European Commission should monitor public finances to identify significant deviations (or, in the language of the Treaty, “gross errors”) that could endanger the macroeconomic and financial stability of the monetary union. 1  Aizenman, J., M. Hutchison, and Y. Jinjarak. (2013). “What is the risk of European sovereign debt defaults? Fiscal space, CDS spreads and market pricing of risk”. Journal of International Money and Finance, 34, 37-59. 2  In practice, the SGP implemented these principles through two well-known reference values: 60% for the ratio of government debt to GDP and 3% for the budget deficit-to-GDP ratio. Non-compliant countries entered the corrective arm, which ensured that excessive deficits were corrected in a given period of time. Compliant countries functioned under the preventive arm, which required convergence to medium-term budgetary objectives. Shortcomings of the current fiscal governance framework Thus, the institutional approach to fiscal policies in the EMU rested on the assumption that supranational constraints would yield national budgetary policies consistent with the smooth functioning of the monetary union.
3  See, for example, Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack, “Large-Scale Asset Purchases by the Federal Reserve: Did They Work?” Federal Reserve Bank of New York Staff Report no. 441, March 2010. Several private-sector firms have estimated yield effects of similar magnitude. In addition, a working paper by James Hamilton and Jing Wu, “The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment,” finds that changes in the Federal Reserve’s asset holdings produce considerable yield effects. 2  BIS Review 128/2010  Under this view, the FOMC’s influence on financial conditions is associated with the size and composition of its securities portfolio. This perspective provides a clear rationale for the reinvestment decision made at the August FOMC meeting. The decline in the size of the Federal Reserve’s portfolio that would have occurred in the absence of the reinvestment program would have amounted to a passive tightening in the stance of monetary policy, as the portfolio balance effect would have gradually reversed. Moreover, the extent of this tightening was increasing in response to the weakening of the economy, as lower longerterm yields were leading to more rapid repayment of MBS. This perverse effect was seen by the FOMC as working against its efforts to reach its dual mandate. In effect, the policy approach that was implemented before the August meeting acted to mute the amplitude of movements in longer-term interest rates.