We show analytically that the credibility problem which has affected the European Stability Pact originates from the insufficient distinction between two reasons for having binding fiscal constraints. The first reason deals with the governments’ tendency to neglect the effects of their fiscal policy on foreign governments (fiscal free-riding). The second reason follows from the governments’ tendency to raise debt by lowering taxes or increasing expenditures, and then to leave it to their successors (fiscal short-termism). An enforcement mechanism relying on governments’ collusion works if the fiscal constraints are not calibrated for curing fiscal short-termism but only for preventing fiscal free-riding.
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Find related papers by JEL classification: E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents H7 - Public Economics - - State and Local Government; Intergovernmental Relations O4 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity
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