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Does the Enlarged European Union Need a Better Fiscal Pact?

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Abstract

In this paper, we set out to examine an efficient fiscal policy framework for a monetary union. We find that a monetary union can survive with diverging fiscal policies and that the financial markets are efficient enough to separate between “good” and “bad” fiscal policies and punish the latter with higher costs of borrowing. Therefore, there is only limited spill over effect of “bad” fiscal policy within a monetary union if financial markets work efficiently. We argue, consequently, that fiscal rules in a monetary union are still important as they allow to overcome incentive incompatibility of national fiscal rules and as they may guide financial markets in assessing sustainability of national fiscal policies. Finally, we argue for adoption of an institutional rule, Fiscal Sustainability Council for enlarged European Union. The Council would periodically assess fiscal policies and set guidelines for annual deficits. We argue that in order to make the FSC relevant, governments would be obliged to deposit with the Council a substantial amount of bonds that would be regularly rolled over by the Council. By doing so, the Council would connect fiscal policy sustainability principle with financial markets and would guide financial markets evaluation of national fiscal policies.

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Bibliographic Info

Paper provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its series Working Papers IES with number 55.

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Length: 20 pages
Date of creation: 2004
Date of revision: 2004
Handle: RePEc:fau:wpaper:wp055

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Keywords: fiscal policy; European Union; sustainability;

References

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  1. Thomas Laubach, 2003. "New evidence on the interest rate effects of budget deficits and debt," Finance and Economics Discussion Series 2003-12, Board of Governors of the Federal Reserve System (U.S.).
  2. Barry Eichengreen & Lucas D. Papademos, 2003. "The Future of the European Growth and Stability Pact," CESifo Forum, Ifo Institute for Economic Research at the University of Munich, vol. 4(2), pages 68-77, October.
  3. George Kopits, 2001. "Fiscal Rules: Useful Policy Framework or Unnecessary Ornament?," IMF Working Papers 01/145, International Monetary Fund.
  4. Alan J. Auerbach, 2003. "Fiscal Policy, Past and Present," NBER Working Papers 10023, National Bureau of Economic Research, Inc.
  5. Charles Wyplosz, 2002. "Fiscal Policy: Institutions vs. Rules," IHEID Working Papers 03-2002, Economics Section, The Graduate Institute of International Studies.
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Cited by:
  1. Terezie Lokajickova, 2010. "Could the Stability and Growth Pact Be Substituted by the Financial Markets?," Working Papers IES 2010/30, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Dec 2010.
  2. Takayama, Noriyuki, 2013. "Intergenerational Equity and the Gender Gap in Pension Issues," CIS Discussion paper series 605, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.

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