Discussion Paper Details

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Title: Reconciling Stability and Growth: Smart Pacts and Structural Reforms

Author(s): Roel Beetsma and Xavier Debrun

Publication Date: June 2003

Keyword(s): monetary union, stability and growth pact and Structural reforms

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

Beetsma, R and Debrun, X. 2003. 'Reconciling Stability and Growth: Smart Pacts and Structural Reforms'. London, Centre for Economic Policy Research.