Working Paper: CEPR ID: DP3930
Authors: Roel Beetsma; Xavier Debrun
Abstract: This Paper analyses the decision of a government facing electoral uncertainty to implement structural reforms in the presence of fiscal restraints similar to the Stability and Growth Pact. We provide suggestive evidence that structural reforms - in particular labour market reforms - may lead to substantial outlays by the government, for example to buy political support. To the extent that the reform package entails up-front costs, the model shows that a pact may harm structural reforms, sacrificing future growth for present stability. Since electoral uncertainty creates an expansive fiscal bias, the welfare gains brought about by a pact depend on a trade-off between the reduction in the deficit bias and the induced reduction in the amount of structural reform. Imposing a pact becomes more attractive if it takes into account the up-front costs from structural reforms when evaluating the member states' fiscal stance. Therefore, the analysis lends support to a recent proposal by the European Commission for a more flexible implementation of the Stability and Growth Pact in this respect.
Keywords: monetary union; stability and growth pact; structural reforms
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 |
|---|---|
| electoral uncertainty (K16) | fiscal policy decisions (E62) |
| fiscal policy decisions (E62) | structural reforms (E69) |
| stability pact (F55) | structural reforms (E69) |
| stability pact (F55) | fiscal discipline (E62) |
| fiscal discipline (E62) | structural reforms (E69) |
| stability pact (F55) | deficits (H62) |
| deficits (H62) | structural reforms (E69) |