This book presents the report on the European economic system, which was submitted to the President of the European Commission in July 2003. The report is divided into three parts. The first contains an assessment of the economic performance in terms of growth, stability, and cohesion. The second explores the challenges facing the European Union. The third presents a series of policy recommendations for the future.

An early criticism of the Stability and Growth Pact (SGP) has pointed to its asymmetric nature and the weak mechanisms to prevent politically-motivated fiscal policies: its constraints would bite in downswings but not in upswings, especially if, in the latter, the electoral cycle increases the temptation to run expansionary policies. We find that the experience of the initial years of EMU lends support to this criticism. Overall, unlike the experience in the run-up to EMU, fiscal policies had an expansionary bias, and a 'genuine' discretionary boost took place in correspondence to political elections. Both sign and composition of such discretionary changes are in line with the predictions of the recent literature on electoral budget cycles. Closer fiscal surveillance may help detect such behaviour early on, but it is unlikely to curb the incentives to run politically-motivated fiscal policies when elections approach. Copyright Blackwell Publishing Ltd 2004.

Under the Stability and Growth Pact, countries are committed to achieve medium-term budget positions of 'close-to-balance or in surplus'. The rationale for this commitment is that such budgetary positions would allow for the full working of the built-in stabilizers without triggering the sanctions procedures of the Pact. This article sets out to show how quantifications of the medium-term (structural) requirement can accommodate the desired aim and suggests how fiscal measurement and forecasting errors as well as the budgetary effects of ageing may be allowed for. All in all, broadly balanced budgets in the medium term appear to be 'roughly right' for most euro-zone countries. Of course, as the cyclical behaviour of the euro-zone economy adapts to the new EMU environment, the medium-term targets will need to be addressed again.

The economic and financial crisis and its aftermath have put economic and monetary union (EMU) to the test and exposed gaps in its initial policy architecture. Collective rules of fiscal discipline have proven difficult fully to enforce and excessive public indebtedness has been confirmed as a potential source of systemic instability. Broader economic and financial imbalances have also been shown to carry important risks for individual Member States' and area‐wide stability. Recent governance reforms have sought to address these shortcomings. In particular, the so‐called ‘Six‐Pack’ has brought changes strengthening the ability to prevent and correct economic and fiscal imbalances in the future. With the crisis not terminated, however, the debate over optimal policy arrangements continues and additional governance reforms have been put forward. This article reviews some lessons drawn from the crisis episode for the economic and budgetary framework of EMU and describes the governance reforms that have been undertaken as part of the comprehensive solution needed to underpin the single currency.

The article analyses in a simple setting a game between an inflationconservative central bank and a fiscal authority subject to an upper limit on the budget deficit. It is shown that complementarity or substitutability between the policies and the preference of each authority for the other authority's behaviour crucially depends on the type of shock hitting the economy. If the government attempts to stimulate output beyond its natural level, a 'deficit bias' emerges under non-co-operation; under co-operation, the equilibrium is characterized by both a 'deficit bias' and an 'inflation bias'. However, if the government only pursues cyclical stabilization these biases disappear and there are positive gains from co-ordinating the policy responses to shocks. * Earlier versions of this article have been presented in several conferences and workshops. We would like to thank discussants and participants for thoughtful comments. In particular, we are grateful to Ralph Bryant, Luisa Lambertini and, especially, Jacques Mélitz. We are also indebted to a number of Commission colleagues, two anonymous referees and the editor of this journal for valuable comments. Maarten van de Stadt provided excellent research assistance. The opinions expressed are those of the authors only and should not be attributed to the European Commission. The usual disclaimer applies. 802

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"Economic reform is sometimes seen as damaging to a government's re-election chances, but anecdotal evidence from OECD countries would not seem to strongly support this perception. This paper tests this hypothesis on a sample of 21 OECD countries over the period 1985-2003, controlling for other economic and political factors that may affect re-election. It is found that the chances of re-election for incumbent governments are not significantly affected by their record of pro-market reforms. However, the electoral impact of reform is found to differ strongly depending on which types of policies are considered. In particular, reform measures that are more likely to hurt large groups of 'insiders' seem electorally more damaging. A series of framework conditions appears to affect the impact of reforms on re-elections. Reformist governments in countries with rigid product and labour markets tend to be voted out of office, suggesting the existence of a 'rigidity trap'. While fiscal stimulus is not an effective instrument to 'sweeten the pill' and raise the odds of re-election, the presence of liberal financial markets appears to soften electoral resistance to structural reform. The latter finding is of particular relevance in the current financial crisis: forward-looking governments should not rush to over-regulate financial markets in order not to compromise the feasibility of product and labour market reforms". Copyright (c) CEPR, CES, MSH, 2010.