Countries with larger fiscal deficits have had a more procyclical policy both in good times and in bad times. A Commission paper finds a significant impact of elections on procyclicality, especially procyclical tax cuts. In addition, the structural deficits are most likely higher than presumed. With lower potential growth, the ECB will need to push the brakes earlier and more forcefully than most people assume. Hence, the long awaited help from growth to fix the deficit problems and the debt-to-GDP ratios will most likely not materialize. Deficits and debts could  4  BIS Review 88/2006  deteriorate even further when pressures from an ageing population will kick in within the next five years. Is there a solution? Let me first note an interesting development: 1999-2004 the average yearly fiscal deficit in the euro area has been 1.9 per cent of GDP while the average yearly (unweighted) surplus of the three old outcountries (the UK, Denmark and Sweden) has been 1.1 per cent of GDP. This despite the fact that the UK has moved from a comfortable surplus position to a deficit of 3.3% of GDP in 2004. Some euro-sceptics will of course attribute this difference to monetary union itself but I think the difference is rather that all three out-countries have been forced to find new ways of building a strong national macroeconomic framework based on clearly stated goals and a transparent evaluation of how these goals are to be met, in addition to the common EU rules.
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 in a credible fashion. But, in addition, the conclusion is also that the temptation to over-expand is as strong during an upturn as during a downturn. In fact this is what we have seen in the euro area during the heyday of the late 1990s and the beginning of the 21st century – a much too expansionary fiscal stance in some euro area countries, especially in good times, which led to tighter monetary policy by the ECB and thus an incentive for others to further weaken fiscal discipline. When the downturn eventually came, the euro area entered this phase with large deficits instead of surpluses. What the Pact then required, a 180-degree turnaround in fiscal policy to a tighter stance, reinforced the downturn and was considered by some as stupid. In fact it was the lack of savings  BIS Review 88/2006  1  during the boom that was stupid. Thus, rules would be needed not only for a maximum deficit in a downturn, but equally some forceful rule for fiscal rectitude in good times.