Working Paper: CEPR ID: DP2167
Authors: Roel M. W. J. Beetsma; Henrik Jensen
Abstract: We show how a stability pact based on deficit sanctions eliminates the exacerbation of debt accumulation that may arise from monetary unification. Moreover, by making sanctions contingent upon the economic situation of countries, the stability pact provides for risk sharing. Differences in initial debt levels, however, reduce the scope for unanimous support for a pact. We introduce alsoendogenous ``fiscal discipline'' whose unobservability leads to moral hazard in its provision. If countries are ex ante identical, it is nevertheless optimal to make sanctions at least to some extent contingent on countries' economic situation. However, with cross-country differences in the costs of providing discipline, some countries may oppose such contingency.
Keywords: stability pact; monetary union; public debt; risk sharing; fiscal discipline
JEL Codes: E42; E61; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stability pact design (E63) | debt accumulation (H63) |
| stability pact design (E63) | fiscal behavior of countries (E62) |
| stability pact design (E63) | risk sharing (D16) |
| initial debt levels (F34) | support for stability pact (F55) |
| moral hazard (G52) | fiscal responsibility (E62) |
| stability pact design (E63) | moral hazard (G52) |