DP3496 Patching up the Pact: some Suggestions for Enhancing Fiscal Sustainability and Macroeconomic Stability in an Enlarged European Union

Author(s): Willem H. Buiter , Clemens Grafe

Publication Date: August 2002

Keyword(s): stability and growth pact , EU accession , fiscal sustainability , golden rule , tax smoothing

JEL(s): E32 , E42 , E61 , E62 , E63 , F33 , F42 , H62 , H87

Programme Areas: International Macroeconomics , Transition Economics

Link to this Page: www.cepr.org/pubs/dps/DP3496.asp

The paper considers the implications for the EU accession candidates of Central and Eastern Europe of the fiscal-financial constraints imposed by the Stability and Growth Pact and the Maastricht Treaty. Our findings apply also to those current EU members whose initial conditions (e.g. infrastructure and progress in state pension reform) or other structural characteristics (e.g. demographic structure, growth potential, Balassa-Samuelson equilibrium real exchange rate appreciation) differ significantly from the EU average. We find the existing criteria to be seriously flawed and propose an alternative rule, the Permanent Balance Rule, based on a strong from of tax smoothing.