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Reconciling Stability and Growth: Smart Pacts and Structural Reforms

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  • Beetsma, Roel
  • Debrun, Xavier

Abstract

This Paper analyses the decision of a government facing electoral uncertainty to implement structural reforms in the presence of fiscal restraints similar to the Stability and Growth Pact. We provide suggestive evidence that structural reforms - in particular labour market reforms - may lead to substantial outlays by the government, for example to buy political support. To the extent that the reform package entails up-front costs, the model shows that a pact may harm structural reforms, sacrificing future growth for present stability. Since electoral uncertainty creates an expansive fiscal bias, the welfare gains brought about by a pact depend on a trade-off between the reduction in the deficit bias and the induced reduction in the amount of structural reform. Imposing a pact becomes more attractive if it takes into account the up-front costs from structural reforms when evaluating the member states' fiscal stance. Therefore, the analysis lends support to a recent proposal by the European Commission for a more flexible implementation of the Stability and Growth Pact in this respect.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3930.

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Date of creation: Jun 2003
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Handle: RePEc:cpr:ceprdp:3930

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Keywords: monetary union; stability and growth pact; Structural reforms;

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  1. Saint-Paul, Gilles, 2004. "Macroeconomic Fluctuations and the Timing of Labor Market Reform," IDEI Working Papers 314, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Gert Schnabel, 2002. "Output trends and Okun's law," BIS Working Papers 111, Bank for International Settlements.
  3. Saint-Paul, Gilles, 2002. "Some Thoughts on Macroeconomic Fluctuations and the Timing of Labor Market Reform," IZA Discussion Papers 611, Institute for the Study of Labor (IZA).
  4. Sibert, Anne & Sutherland, Alan, 2000. "Monetary union and labor market reform," Journal of International Economics, Elsevier, vol. 51(2), pages 421-435, August.
  5. Rogoff, Kenneth, 1990. "Equilibrium Political Budget Cycles," American Economic Review, American Economic Association, vol. 80(1), pages 21-36, March.
  6. Saint-Paul, Gilles, 1999. "The Political Economy of Employment Protection," CEPR Discussion Papers 2109, C.E.P.R. Discussion Papers.
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