DP3930 Reconciling Stability and Growth: Smart Pacts and Structural Reforms

Author(s): Roel Beetsma, Xavier Debrun
Publication Date: June 2003
Keyword(s): monetary union, stability and growth pact, Structural reforms
JEL(s): E42, E61, F33
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3930

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.