What is the stability and growth pact?
It is an agreement between members of the eurozone to rein in government borrowing. Countries must keep the gap between government spending and revenues to less than 3% of national income.
What's wrong with a deficit?
If governments carry on spending beyond their means, their debt burden rises. The bond markets take a dim view of big borrowers because they believe governments have an incentive to fire up inflation which will reduce the real value of its loans. To compensate for that risk, they may charge higher long-term interest rates. In a currency union, the cost would be paid by all other members as well, so there is an incentive for individual members to overspend.
Isn't it the job of the European Central Bank to control inflation?
That's true and probably why long-term official borrowing rates in the eurozone have all converged at low levels - the markets believe Italy is as a good a risk as the Germans always were because the ECB is tough on inflation.
So why do they need the pact?
Supporters of the pact say that if Italy's debts became unsustainable and it were forced to default, the fallout would hurt fellow members. Although they are not obliged to bail out other governments in trouble, financial systems in the eurozone are now more integrated, and a default in one country would hurt the others.
