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An Analysis of the Stability Pact

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  • Uhlig, H.F.H.V.S.
  • Beetsma, R.M.W.J.

    (Tilburg University, Center for Economic Research)

Abstract

We analyse the proposed "Stability Pact" for countries joining a European Monetary Union (EMU). In an EMU shortsighted governments fail to fully internalise the inflationary consequences of their debt policies. This results in excessive debt accumulation. Therefore, while in the absence of EMU governments have no incentive to sign a stability pact, under an EMU they prefer a stability pact which punishes excessive debt accumulation. With idiosyncratic shocks to the governments' budgets, an EMU combined with an appropriately designed stability pact will be strictly preferred to autonomy. While the stability pact corrects the average debt bias, inflation, which is attuned to the union-average debt level, is more stable.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 1997-59.

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Date of creation: 1997
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Handle: RePEc:dgr:kubcen:199759

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Keywords: Stability Pact; European Monetary Union; political distortions; monetary policy; debt policy; inflation;

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References

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  1. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January.
  2. Eijffinger, S. & De Hann, J., 1995. "The Political Economy of Central Bank Independence," Papers 9587, Tilburg - Center for Economic Research.
  3. Obstfeld, Maurice, 1997. "Dynamic Seigniorage Theory: An Exploration," Department of Economics, Working Paper Series qt712610vq, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  4. Jensen, Henrik, 1994. "Loss of monetary discretion in a simple dynamic policy game," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 763-779.
  5. Rudi Dornbusch, 1996. "Debt and Monetary Policy: The Policy Issues," NBER Working Papers 5573, National Bureau of Economic Research, Inc.
  6. Bovenberg, A.L. & Beetsma, R.M.W.J., 1997. "Central Bank independence and public debt policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-74443, Tilburg University.
  7. Tabellini, Guido & Alesina, Alberto, 1990. "Voting on the Budget Deficit," American Economic Review, American Economic Association, vol. 80(1), pages 37-49, March.
  8. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 403-14, July.
  9. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  10. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Does Monetary Unification Lead to Excessive Debt Accumulation?," DELTA Working Papers 95-23, DELTA (Ecole normale supérieure).
  11. Alberto Giovannini, 1996. "The Debate on Money in Europe," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071681, December.
  12. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, vol. 82(3), pages 537-55, June.
  13. Uhlig, Harald, 1997. "Long Term Debt and the Political Support of a Monetary Union," CEPR Discussion Papers 1603, C.E.P.R. Discussion Papers.
  14. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  15. van der Ploeg, Frederick, 1995. "Political Economy of Monetary and Budgetary Policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 427-39, May.
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Cited by:
  1. Andrew Hughes Hallett, 2008. "Sustainable fiscal policies and budgetary risk under alternative monetary policy arrangements," Economic Change and Restructuring, Springer, vol. 41(1), pages 1-28, March.
  2. Gian-Maria Milesi-Ferretti, 2000. "Good, Bad or Ugly?on the Effects of Fiscal Rules with Creative Accounting," IMF Working Papers 00/172, International Monetary Fund.
  3. Sutter, Matthias, 2000. " Flexible Integration, EMU and Relative Voting Power in the EU," Public Choice, Springer, vol. 104(1-2), pages 41-62, July.
  4. Russell Cooper & Hubert Kempf, 2000. "Designing Stabilization Policy in a Monetary Union," Boston University - Institute for Economic Development 99, Boston University, Institute for Economic Development.
  5. Samir Jahjah, 2001. "Financial Stability and Fiscal Crises in a Monetary Union," IMF Working Papers 01/201, International Monetary Fund.
  6. Huizinga, Harry & Nielsen, Soren Bo, 1998. "Is Coordination of Fiscal Deficits Necessary?," CEPR Discussion Papers 1936, C.E.P.R. Discussion Papers.
  7. Detken, Carsten, 1999. "Fiscal policy effectiveness and neutrality results in a non-Ricardian world," Working Paper Series 0003, European Central Bank.
  8. Xavier Debrun, 2000. "Fiscal Rules in a Monetary Union: A Short-Run Analysis," Open Economies Review, Springer, vol. 11(4), pages 323-358, October.
  9. W. Bolt, 1999. "Fiscal Restraints, ECB Credibility and the Stability Pact:A Game-Theoretic Perspective," DNB Staff Reports (discontinued) 38, Netherlands Central Bank.
  10. Bernhard Winkler, 1999. "Co-ordinating Stability: Some Remarks on the Roles of Monetary and Fiscal Policy under EMU," Empirica, Springer, vol. 26(3), pages 287-295, September.
  11. Marco Catenaro, 2000. "Macroeconomic Policy Interactions in the EMU: A Case for Fiscal Policy Co-ordination," School of Economics Discussion Papers 0003, School of Economics, University of Surrey.

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