An analysis of the stability and growth pact

We use a stylised model to analyse the Stability and Growth Pact for countr ies that have formed the European Monetary Union (EMU). In our model, short sighted governments fail to internalise the consequences of their debt poli cies for the common inflation rate fully. Therefore, while governments have no incentive to sign a stability pact in the absence of a monetary union, they do so with monetary union to restrain this externality. With uncertain ty, a monetary union combined with an appropriately designed pact will he s trictly preferred to autonomy. With differences in initial conditions, conf licts of interest arise. We study the Nash bargaining solution.