The Stability Pact: more than a minor nuisance?

The Stability and Growth Pact will lead member countries to aim for cyclically balanced budgets. Until this steady state is reached, Europe will continue its efforts at deficit cutting. While so doing, politicians are less likely to undertake the difficult labour market reforms that are really neede...

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Bibliographic Details
Published in:Economic policy 1998-04, Vol.13 (26), p.65-113
Main Authors: Eichengreen, Barry, Wyplosz, Charles
Format: Article
Language:English
Subjects:
Banking crises
Bond markets
Budget deficits
Economic recessions
Federal budget deficit
Fiscal policy
Gross domestic product
Interest rates
Public debt
Treaties
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Summary:The Stability and Growth Pact will lead member countries to aim for cyclically balanced budgets. Until this steady state is reached, Europe will continue its efforts at deficit cutting. While so doing, politicians are less likely to undertake the difficult labour market reforms that are really needed. Is further fiscal retrenchment wise? The paper reviews the reasons that have been advanced in favour of a Stability Pact and finds them wanting. The most serious justifications, such as the systemic risk of bank crisis following a government's failure to service its debt, can be better dealt with in other ways: for example, by prudential limits on banks' exposure to public debts. Moreover, our analysis reveals that the macroeconomic costs of the Stability Pact, while sizeable, are not as dangerous as often believed. The costs will be barely visible once the steady state is reached. The true macroeconomic costs are front loaded; they concern the next few years, after a decade already dominated by convergence efforts.
ISSN:0266-4658
1468-0327
DOI:10.1111/1468-0327.00029