Mixtures of Ag1-xPdx (x=0.2, 0.3) and doped PZT ceramic powders have been heat treated in air and the resulting phase content has been analyzed by X-ray diffraction and transmission electron microscopy. Beginning around 400 degrees C, a phase similar to PbPdO2 is formed on the surface of the Ag1-xPdx particles and subsequently decomposes at temperatures < 700 degrees C. Consequently, the remaining Ag1-xPdx powder becomes significantly silver-rich while the reaction progresses. After decomposition the Pd appears to realloy and the initial Ag1-xPdx composition is recovered. We show that the reaction is all but eliminated in a nitrogen atmosphere. The occurrence of this reaction was also investigated in PZT multilayer actuators cofired with Ag0.7Pd0.3 electrodes. Transmission electron microscope analysis revealed the presence of distinct crystallites at the electrode-ceramic interface, most likely nucleated from a PbO liquid phase arising from the decomposition of PbPdO2.