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Does Europe Need Stability or Flexibility?

German Chancellor Gerhard Schröder is pushing for a looser interpretation of the EU budgetary rules designed to protect the euro. A revamp of the stability pact looks likely, but will that hurt or help Europe's economy?

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The pact is meant to safeguard the euro's value

The euro may be riding high against the US dollar in the world's foreign exchange markets these days, but it wasn't always that way. Not long after the currency replaced France's franc, Italy's lira and Germany's precious mark in 1999, there were months when it looked like the euro's slide against the greenback might never stop.

Back then, no European politician dared criticize the EU's Growth and Stability Pact, the budgetary rules designed to underpin the euro. Setting out deficit limits aimed at curbing profligate spending, the pact was at the time considered crucial in efforts to make the euro more like the stable deutsche mark than the wobbly Italian lira.

Informelles Treffen, Schröder Chirac in Berlin

"You're over 3.0 percent? So am !"

But times have changed. The two largest euro-zone economies, Germany and France, have both repeatedly violated the pact's deficit limit. They have also torpedoed the European Commission's efforts to pursue disciplinary measures against those EU states that breach the pact's deficit cap of 3.0 percent of a euro state's gross domestic product (GDP).

Berlin pushes for revamp

Whereas Germany was one of the main proponents of setting a deficit cap of 3.0 percent of gross domestic product (GDP) for euro members, Berlin is now leading the charge for a more flexible interpretation of the pact. And that makes some economists nervous.

"The euro holds its own these days due to the good work of the European Central Bank over the past few years. Therefore one shouldn't talk about loosening the stability pact," Thomas Straubhaar, president of the Hamburg Institute of International Economics, told DW-TV. "We shouldn't forget that the stability pact isn't tailored to Germany alone -- it's valid for the entire euro zone. Which means one country alone can't claim it's suffering unduly because of it."

Chancellor Schröder and his finance minister, Hans Eichel, have chaffed at the budgetary rules at a time when Germany is struggling with high unemployment and weak growth. Both publicly support the goal of budgetary consolidation; however, they also argue that rigidly following the stability pact endangers the recovery of Europe's largest economy.

Accordingly, Schröder wants EU's leaders at a summit in March to reinterpret the pact's rules that would give his government more leeway.

"The decisive criterion has to be a credible growth and employment policy that gives member states the necessary fiscal room for maneuver," Schröder wrote in a special guest article for the Financial Times newspaper last week.

The chancellor wants Brussels to cut euro-zone members some slack, so long as they have a plan in place for structural reform and for eventually getting their deficits and public debt under control. He touts his so-called Agenda 2010, a package of labor market reforms and welfare cuts, as such a program.

Brussels gives in

After long fighting a weakening of the pact, it now appears as if Brussels is willing to play along. EU Monetary Affairs Commissioner Joaquin Almunia has said he will take into account such things like Germany's efforts to rebuild its depressed formerly communist east.

Gemeinschaftswerk Aufschwung Ost in Magdeburg

"When we judge the financial situation of a land, all relevant factors play a role. Naturally I consider that to include the enormous challenge of German unity," EU Monetary Affairs Commissioner Joaquin Almunia told German news magazine Focus on Monday.

That would ease pressure on Berlin to slash its deficit. However, some observers are skeptical whether a more flexible pact will do much to stimulate growth in Germany or anywhere else in the euro zone.

"I'm not sure it'll make a difference for growth," Katinka Barysch, chief economist at the London-based think tank the Center for European Reform, told DW-WORLD. "France and Germany haven't stuck to the deficit limits anyway and it's hard to see how that's helped their growth."

She said the revamped stability pact would likely be stripped of the threat of financial sanctions for euro members, but that peer pressure against fiscally wayward states might increase. That could mean a rough time ahead for Greece, which deliberately misled the commission about its high budget deficit for years.

But even then, the rules will only be as tough as euro-zone countries are willing to enforce them. "The stability pact is just a tool. But it's the only game in town," said Barysch.

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