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Could the Stability and Growth Pact Be Substituted by the Financial Markets?

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In the discussions of the need for fiscal rules and their usefulness in a monetary union researchers have not agreed on whether the financial markets have a sufficiently disciplining effect on the governments, which would mean that the fiscal rules are not necessary. This paper investigates whether the European Union’s main fiscal rule, the Stability and Growth Pact, could be substituted by the financial markets, taking into account also the effects of the latest financial and economic crisis. Our findings suggest that there is certain interaction between the financial markets and the governments’ decisions on the fiscal policies and that this reaction has become stronger after the beginning of the crisis. However, the institutional setup and market conditions in the European Union are such that this interaction is biased and thus we conclude that the Union needs to have fiscal rules.

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Paper provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its series Working Papers IES with number 2010/30.

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Length: 29 pages
Date of creation: Dec 2010
Date of revision: Dec 2010
Handle: RePEc:fau:wpaper:wp2010_30

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Keywords: European Economic and Monetary Union; Stability and Growth Pact; Financial markets; Fiscal rules;

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  14. Beetsma, Roel & Debrun, Xavier & Klaassen, Franc, 2001. "Is Fiscal Policy Coordination in EMU Desirable?," CEPR Discussion Papers 3035, C.E.P.R. Discussion Papers.
  15. George Kopits, 2001. "Fiscal Rules: Useful Policy Framework or Unnecessary Ornament?," IMF Working Papers 01/145, International Monetary Fund.
  16. Petr Hedbávný & Ondřej Schneider & Jan Zápal, 2004. "Does the Enlarged European Union Need a Better Fiscal Pact?," Working Papers IES 55, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised 2004.
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  18. Paesani, Paolo & Strauch, Rolf & Kremer, Manfred, 2006. "Public debt and long-term interest rates: the case of Germany, Italy and the USA," Working Paper Series 0656, European Central Bank.
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