THE STABILITY PACT - MORE THAN A MINOR NUISANCE

The Stability and Growth Pact will lead member countries to aim for cy clically balanced budgets. Until this steady state is reached, Europe will continue its efforts at deficit cutting. While so doing, politici ans are less likely to undertake the difficult labour market reforms t hat are really needed. Is further fiscal retrenchment wise? The paper reviews the reasons that have been advanced in favour of a Stability P act and finds them wanting. The most serious justifications, such as t he systemic risk of bank crisis following a government's failure to se rvice its debt, can be better dealt with in other ways:for example, by prudential limits on banks' exposure to public debts. Moreover, our a nalysis reveals that the macroeconomic costs of the Stability Pact, wh ile sizeable, are not as dangerous as often believed. The costs will b e barely visible once the steady state is reached. The true macroecono mic costs are front loaded; they concern the next few years, after a d ecade already dominated by convergence efforts.