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.
Find related papers by JEL classification: E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
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