An Analysis of the Stability Pact

H.F.H.V.S. Uhlig, R.M.W.J. Beetsma

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Abstract

We analyse the proposed "Stability Pact" for countries joining a European Monetary Union (EMU). In an EMU shortsighted governments fail to fully internalise the inflationary consequences of their debt policies. This results in excessive debt accumulation. Therefore, while in the absence of EMU governments have no incentive to sign a stability pact, under an EMU they prefer a stability pact which punishes excessive debt accumulation. With idiosyncratic shocks to the governments' budgets, an 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.
Original languageEnglish
Place of PublicationTilburg
PublisherMacroeconomics
Number of pages25
Volume1997-59
Publication statusPublished - 1997

Publication series

NameCentER Discussion Paper
Volume1997-59

Keywords

  • Stability Pact
  • European Monetary Union
  • political distortions
  • monetary policy
  • debt policy
  • inflation

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