“Post-Crisis Lesson for EMU Governance from the Principal-Agent Approach” released

The global crisis exposed the weaknesses of economic governance in the EU, casting a shadow over the idea of a single currency zone. Even the Stability and Growth Pact did not hinder some of the Member States from enlarging their public debt. In “Post-Crisis Lesson for EMU Governance from the Principal-Agent Approach”, a revised version of a paper originally presented at the Euroframe conference in Warsaw on May 24th, Luca Barbone and Grzegorz Poniatowski address these issues, giving suggestions on how to contain or reduce debt and apply sustainable countercyclical fiscal policy. They do so by applying a game-theoretic principal-agent approach, where they develop a model in which the EMU authorities act as a collective principal that designs contracts for each of two agents that reflect Europe’s “South” and “North”. According to the authors, tailor-made solutions are the most effective as they can demand more effort from those agents that struggle most with fiscal discipline by offering more appealing incentives.  

The authors argue that EU institutions should focus on creating stronger and more credible incentives to reduce deficits during sound economic times. Barbone and Poniatowski argue that these incentives – both punitive and compensatory – should be enforced using strict rules whose breach will result in immediate consequences. This is in contrast with today’s procedures, which take too much time and are thus ineffective when the need for discipline arises. Furthermore, in their considerations, Barbone and Poniatowski take into account spill-over effects resulting from the impact of the countries’ policies on each other and show how to effectively take advantage of positive spill-over effects.