Monetary union raises many other institutional questions that I will not be taking up today. Not the least of these is relations with countries and organisations outside the European Union. Where, for instance, does the primary responsibility for the exchange rate lie in Europe and what about relations between euro area countries and the International Monetary Fund? I now want to hark back to the issues I touched on earlier: fiscal policy in relation to the business cycle, and how the labour market functions. How will these matters be handled in the system for economic policy decisions? Cyclical disparities and fiscal policy  BIS Review 50/1998  -7-  The past year has seen a general strengthening of economic activity in the EU area. This has helped improve government finances and provided better conditions in other respects for the start of monetary union. But it has been accompanied by increased cyclical disparities between the future euro countries. This is clear from a look at how observers have revised their growth predictions as compiled, for example, in “consensus forecasts”. A look at the euro countries divided into two groups with higher and lower predicted GDP growth, respectively, shows that in the past year the gap between these groups has widened. The same applies in terms of predicted inflation. One should not make too much of this; the differences have grown but are still small and assessments for 1999 suggest that they will narrow again. But the picture does illustrate a problem that will have to be addressed.
The Pact has been constructed with a view to generating so much pressure on Member States to put government finances in order that sanctions will never be necessary. A knotty problem when constructing the Pact was how to make the requirements sufficiently strict without placing undue restrictions on national fiscal policies. This is all the more important when monetary policy is no longer available at national level, so that the task of adjustment falls more heavily in practice on fiscal policy. OECD estimates indicate that in a “normal” economic downturn, the cyclical budget balance in EU countries weakens by 1-1.5 per cent of GDP. Some budgetary discretion is therefore needed so that there is a margin for automatic stabilisers to act when activity is falling. The conclusion is that the trade-off seems reasonable but the Pact does make it necessary to achieve a balanced budget or a surplus relatively soon. Under these circumstances, the Swedish government’s ambition to establish an annual budget surplus of 2 per cent over the business cycle is commendable. Fiscal policy accordingly faces new challenges and it is not all that easy to tell just what may happen. When monetary policy ceases to be a national instrument, fiscal policy will have to play a greater part in stabilisation policy.