An Analysis of the "Stability Pact"
CEPR Discussion Paper Series Number 1669
Posted: 27 Jan 1998
Date Written: July 1997
We analyze the proposed "stability pact" for countries joining a European Monetary Union (EMU). Within EMU short-sighted governments fail to fully internalize the inflationary consequences of their debt policies, which results in excessive debt accumulation. Hence, although in the absence of EMU governments have no incentive to sign a stability pact, within EMU they prefer a stability pact which punishes excessive debt accumulation. With idiosyncratic shocks to governments' budgets, 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.
JEL Classification: E58, E60, E61, E63, F33, F42
Suggested Citation: Suggested Citation