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Post-Crisis Lesson for EMU Governance from the Principal-Agent Approach

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  • Luca Barbone
  • Grzegorz Poniatowski

Abstract

This paper contributes to the ongoing debate on fiscal consolidation and the questionable effectiveness of the Stability and Growth Pact by addressing the problem of economic governance in the EMU with a game-theoretic principal-agent approach. Following the theory of delegation, we develop a principal-multi agent model where the EMU authorities act as a collective principal that designs contracts for each of two agents that reflect Europe’s ”South” and ”North”. We investigate what happens when agents face hidden-information moral hazard problem and when they are able to coordinate their actions. Bearing in mind the applicability of incentive mechanisms, we discuss the optimal contracts for the principal and each of the agents. We prove that the most efficient solution consists of tailor-made contracts, according to which highly indebted countries must be offered strong incentive mechanisms in the form of substantial penalties but also rewards (e.g., preferential loans). We also stress the importance of taking into account positive spillover effects, which could be facilitated by economic integration and fiscal policy coordination between the EMU Members.

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Bibliographic Info

Paper provided by CASE-Center for Social and Economic Research in its series CASE Network Studies and Analyses with number 0457.

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Length: 27
Date of creation: Jul 2013
Date of revision:
Handle: RePEc:sec:cnstan:0457

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Keywords: Moral Hazard; Principal-Agent; EU Economic Governance; Fiscal Compact;

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References

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  1. Macho-Stadler, Ines & Perez-Castrillo, J. David, 2001. "An Introduction to the Economics of Information: Incentives and Contracts," OUP Catalogue, Oxford University Press, edition 2, number 9780199243259, October.
  2. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  3. Nordhaus, William D, 1975. "The Political Business Cycle," Review of Economic Studies, Wiley Blackwell, vol. 42(2), pages 169-90, April.
  4. Marek Dabrowski, 2012. "Fiscal and Monetary Policy Determinants of the Eurozone Crisis and its Resolution," CASE Network Studies and Analyses 443, CASE-Center for Social and Economic Research.
  5. Waltraud Schelkle, 2005. "The Political Economy of Fiscal Policy Co-ordination in EMU: From Disciplinarian Device to Insurance Arrangement," Journal of Common Market Studies, Wiley Blackwell, vol. 43(2), pages 371-391, 06.
  6. Michael Gavin & Roberto Perotti, 1997. "Fiscal Policy in Latin America," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 11-72 National Bureau of Economic Research, Inc.
  7. Jakob von Weizsäcker & Jacques Delpla, 2010. "The Blue Bond Proposal," Policy Briefs 403, Bruegel.
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Cited by:
  1. Grzegorz Poniatowski, 2014. "Common Currency and Determinants of Government Bond Risk Premiums," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 6(2), pages 70-87, June.

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