Two naked emperors? Concerns about the Stability & Growth Pact and second thoughts about central bank independence

This paper addresses two sets of issues relevant to current and prospective future E(M)U members: the consequences of the Stability & Growth Pact for fiscal-financial sustainability and macroeconomic stability, and some risks associated with operational independence of the central bank. To be effective as a lender of last resort or to stabilise demand when short nominal interest rates are close to their zero lower bound, the central bank must coordinate and cooperate with the fiscal authorities. Central bank independence is unlikely to survive if such coordination and cooperation are not forthcoming.