Fiscal Discipline as a Social Norm: The European Stability Pact

Authors


  • Jean-Paul Fitoussi and Francesco Saraceno, Observatoire Français des Conjonctures Économiques, 69 Quai d'Orsay, 75007 Paris, France (fitoussi@sciences-po.fr) (francesco.saraceno@sciences-po.fr).

  • The authors thank Robert Solow for his thorough reading of a previous draft. We also benefited of comments by two referees, as well as Philippe Aghion, Alberto Alesina, Pierfederico Asdrubali, Giorgio Basevi, James Forder, Anton Granik, Roberto Perotti, and participants to the Third Lectures on Macroeconomic Governance in the EMU, Siena, May 2006. The comments of two anonymous referees also helped improve the paper.

Abstract

This paper reviews the arguments for and against the “Stability and Growth Pact.” We find the theoretical debate to be inconclusive, as both externality and credibility arguments can be used to yield opposite and plausible conclusions. Empirical evidence in favor of a Pact-like rule is also scant. We therefore suggest the view that the Stability Pact is a public social norm, that countries obey in order to preserve reputation among the other members of the European Union. Using this extreme—but not implausible—hypothesis, we build a simple model similar in spirit to Akerlof's (1980) seminal work on social norms, and we show that reputation issues may cause the emergence of a stable but inferior equilibrium. Increased heterogenity generally has the effect of further reducing aggregate welfare; we conclude that the problems posed by the Pact/social norm are likely to increase following the enlargement, when a number of countries anxious to prove their “soundness” joined the club.

Ancillary