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EMU and Economic Policy in Europe

The Challenge of the Early Years

Edited by Marco Buti and André Sapir

EMU is a completely new policy regime which has significant economic implications and which, it is hoped, will ultimately enhance the role of Europe on the world stage. EMU and Economic Policy in Europe takes stock of the initial experiences of EMU and assesses the challenges which will have to be addressed in the early years of its existence to ensure its long-term objectives are successfully achieved.
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Chapter 5: Fiscal Policy and EMU: Challenges of the Early Years

Antonio Fatás and Ilian Mihov


* Antonio Fatás and Ilian Mihov 1. INTRODUCTION This chapter studies the behaviour of fiscal policy in the EMU countries after January 1999 and the challenges faced by national governments in the medium term. To provide a benchmark, we first look at the years that preceded the creation of the single currency area and then we ask whether the first two years after the launch of the euro represent a significant change in the overall trend towards fiscal discipline started with the Maastricht Treaty in 1991. In accordance with the basic prescriptions of this treaty, the current members of the European Economic and Monetary Union went through significant fiscal adjustments in preparation for the introduction of the new currency. In some cases, these adjustments took place in an unfavourable economic environment due to the low growth rates experienced during the first half of the 1990s. Overall, the process of fiscal adjustment complied with the Maastricht criteria and led to large reductions in budget deficits, especially in the years 1994–1997. The introduction of the euro in January 1999 and the replacement of the Maastricht Treaty criteria by the rules of the Stability and Growth Pact have added new challenges in the conduct of fiscal policy under EMU. Although the Stability and Growth Pact should be conducive to an environment characterized by discipline in fiscal policy, there are still many unanswered questions on what is the best way to achieve and monitor that discipline and the effects...

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