| Abstract: | The Stability and Growth Pact, adopted by members of the European Union,imposes tight limits on government deficits. But since the collapse of Communism,Europe has been faced with the problems of economies in transition: and reunifiedGermany—the leading economy of the EU—combines a prosperous western stateand an eastern economy in the process of transition. In a model where unions play akey role in wage bargaining and transition imposes a substantial burden on thenational budget, we analyze the implications of balancing the budget for the path ofunemployment. Where high but temporary costs are financed by raising taxes onemployment to satisfy the Stability and Growth Pact, then the title is a misnomer:relative to a policy of `tax smoothing', the pact increases unemployment and slowsgrowth. In designing fiscal rules for Europe, the benefits of tax smoothing must beweighed in the balance along with the virtues of fiscal discipline. |
