EMU: Optimal Fiscal Strategy and the Punishment Effectiveness

Radu Vranceanu and Thierry Warin

Review of International Economics, 2001, vol. 9, issue 3, 494-504

Abstract: This paper investigates the ability of the Stability and Growth Pact to prevent governments in the “euro zone” from running excessive budget deficits. It is shown that in a static two‐country game, the Pareto‐optimal strategy of no excess deficits cannot be systematically enforced, whatever the toughness of the sanction under the Pact. However, in a multiperiod setting, the Pareto‐optimal configuration of no excess deficits would prevail even if no sanctions were applied to deviant governments. In this case, neither a heavily punitive SGP, nor a centralized budget appears to be helpful in the EMU context.

Date: 2001
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