But the dilemma goes further - given that it is rational for others to expand their budgets it becomes rational for your own country to do so too - even if your instinct is not to “free ride”. Otherwise you might rationally expect to end up among the small minority that does not expand and at the same time still have the tighter monetary policy that results from everyone else expanding. This is the classic “prisoner’s dilemma” from game theory. The conclusion is that it is necessary to have rules for fiscal policy that limit deficits and debt when monetary policy is united and fiscal policy divided, and that these rules need to be followed. But the conclusion is also that the pressure to over-expand is as strong during an upturn as during a downturn. In fact this is what we have seen in the euro zone during the heyday of the late 1990s - a much too expansionary fiscal stance in some euro zone countries, which led to tighter monetary policy and thus an incentive for others to weaken fiscal discipline. The euro zone then started the downturn with large deficits, considering the earlier boom, instead of surpluses. What the Pact then required, a 180-degree turnaround in fiscal policy to a tighter stance, reinforcing the downturn, was considered by some as stupid. In fact it was the lack of savings during the boom that was stupid.
Why not have all EU countries commit themselves to establishing independent bodies with the responsibility of enhancing transparency by conducting independent forecasts of the countries’ deficits and providing recommendations on a regular basis? They would have only an advisory role and their authority would stem from impartiality and expertise. The subject of their recommendations would be the overall fiscal stance - neither the specifics nor indeed the political orientation of fiscal policy. The Excessive Deficit Protocol (EDP) states that member states shall ensure that national procedures in the budgetary area enable them to meet their obligations. It would therefore be in the spirit of the EDP to have EU countries commit themselves to establishing these kinds of bodies. At the very least, these independent bodies would be able to make more reliable and unbiased forecasts as a basis for EU recommendations. Such an arrangement would avoid having unreliable deficit figures before elections, only to “discover” the real state of accounts after the vote - such as has been the case in Portugal, France, Germany, and most spectacularly in Greece recently. By having a similar role as the Congressional Budget Office in the US, the bodies would ensure a reliable and unbiased “reality check” in times of fiscal profligacy.