Working Paper: CEPR ID: DP1669
Authors: Roel M. W. J. Beetsma; Harald Uhlig
Abstract: We analyse the proposed ?stability pact? for countries joining a European Monetary Union (EMU). Within EMU shortsighted governments fail to fully internalize the inflationary consequences of their debt policies, which results in excessive debt accumulation. Hence, although in the absence of EMU governments have no incentive to sign a stability pact, within EMU they prefer a stability pact which punishes excessive debt accumulation. With idiosyncratic shocks to governments? budgets, 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.
Keywords: stability pact; EMU; political distortions; monetary policy; debt policy; inflation
JEL Codes: E58; E60; E61; E63; F33; F42; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stability pact (F55) | alignment of national fiscal policies with collective objectives of the monetary union (E61) |
| stability pact (F55) | reduction of average debt levels (H63) |
| stability pact (F55) | stabilization of inflation (E63) |
| absence of EMU (F36) | no incentive to sign stability pact (F55) |
| establishment of monetary union (F36) | countries better off signing stability pact (F55) |
| stability pact (F55) | zero deficits chosen by national fiscal authorities (H69) |
| stability pact (F55) | correction of average debt bias (G51) |