The effects of uncertainty about countries’ compliance with the Stability and Growth Pact

Abstract

The Stability and Growth Pact (SGP) was established to govern discretionary fiscal policy in the European Monetary Union. This article studies the effects created when there is uncertainty about the members' commitment to respecting the established deficit limits in the SGP. We will show that, even if countries respect the SGP deficit ceiling, the presence of uncertainty about their compliance will bring about higher volatility in key economic variables, which could, in turn, affect unemployment and growth negatively. This finding shows that it is important to reduce uncertainty about the members' commitment towards the SGP.

Essays on fiscal and monetary policy interactions in a monetary union

“…However, in an asymmetric monetary union, a higher uncertainty may lead to the fiscal authorities with a relatively large spending target to higher taxation in a large monetary union, as they take advantage of their partner's fiscal conservatism. Ferre's (2012) last paper extends his previous work (Ferre, 2005(Ferre, , 2008 by investigating the result that uncertainty on the part of one country's compliance with the SGP would have upon union-wide fiscal stance. This uncertainty may arise because of a lack of credibility, inaccurate economic forecasts, macroeconomic imbalances or a lack of reputation for new member-states.…”

“…Under fiscal authorities' cooperation, the two authorities cooperate with each other in order to minimise a joint loss function according to a straightforward utilitarian criterion that corresponds to simply averaging the two loss functions; in particular, = 1 2 ( + ). This is common in all papers in the literature that consider an interconnection between the countries that form a monetary union (see, e.g., Debrun, 2000;Dixit andLambertini, 2001, 2003b;Cavallari and Di Gioacchino, 2005;Ferre, 2008Ferre, , 2012Andersen, 2005bAndersen, , 2008; among others). Thus, under fiscal policies' coordination, the two fiscal authorities choose at the same time their fiscal stances in order to minimise the above joint loss function.…”

“…) > 0. We can find these assumptions in Ferre (2012) under certainty about both countries compliance with the SGP. Ferre ( 2008) considers a similar problem where the terms-of-trade effect is taken as an exogenous shock.…”

“…In what follows, we can replicate the results of specific models in the literature if we proceed to some simple simplifications. 139 In particular, we can get Uhlig (2003) and Ferre (2005) after setting = = = = 0 and for identical countries, we can get Ferre ( 2008) for = = = 0 and by letting ( − ) = , where is an exogenous initial shock in competitiveness, we can get Andersen (2005b) setting = = 0 and Andersen ( 2008) for = 0 for a two-country monetary union with pure shocks, and Ferre (2012) after setting = = = 0 for certainty about both countries compliance with the SGP.…”

“…Look at pages 58-59, where we discuss Andersen (2005b). In this aspect, our model follows Ferre (2008Ferre ( , 2012.…”