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Risk Sharing and Moral Hazard with a Stability Pact

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  • Beetsma, Roel
  • Jensen, Henrik

Abstract

We show how a stability pact based on deficit sanctions eliminates the exacerbation of debt accumulation that may arise from monetary unification. Moreover, by making sanctions contingent upon the economic situation of countries, the stability pact provides for risk sharing. Differences in initial debt levels, however, reduce the scope for unanimous support for a pact. We introduce also endogenous ``fiscal discipline'' whose unobservability leads to moral hazard in its provision. If countries are ex ante identical, it is nevertheless optimal to make sanctions at least to some extent contingent on countries' economic situation. However, with cross-country differences in the costs of providing discipline, some countries may oppose such contingency.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2167.

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Date of creation: Jun 1999
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Handle: RePEc:cpr:ceprdp:2167

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Related research

Keywords: Fiscal Discipline; Monetary Union; Public Debt; Risk Sharing; Stability Pact;

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Cited by:
  1. Dury, Karen & Pina, Alvaro M., 2003. "Fiscal policy in EMU: simulating the operation of the Stability Pact," Journal of Policy Modeling, Elsevier, vol. 25(2), pages 179-206, February.
  2. Alho, Kari, 2002. "The Stability Pack and Inefficiencies in Fiscal Policy Making in EMU," Discussion Papers 715, The Research Institute of the Finnish Economy.
  3. Beetsma, Roel & Jensen, Henrik, 2003. "Contingent deficit sanctions and moral hazard with a stability pact," Journal of International Economics, Elsevier, vol. 61(1), pages 187-208, October.

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