Structural Reforms in the Eurozone: A Case of Self-defeating Expectations?

This work addresses the implications of agents’ expectations about structural reforms in a context characterized by institutional inertia. By means of a stylized small-open economy model encompassing policy-induced barriers to entry in the non-tradable sector, the paper shows that expectations about reforms affect economic performances and alter the incentives for the authorities to implement structural reforms. Moreover, the model shows that it is possible to envisage circumstances under which no set of expectations has the potential for self-fulfillment, thereby creating self-defeating expectations traps. This model sheds light on the recent problems of the Eurozone periphery, characterized by authorities exhibiting a status quo bias against reforms and by a history of self-defeating optimistic expectations about the realization of structural reforms.