Tag Archives: Fiscal union

“Fiskalunion auf tönernen Füssen (Fiscal Union on Shaky Grounds),” FuW, 2015

Finanz und Wirtschaft, October 7, 2015. PDF. Ökonomenstimme, October 9, 2015. HTML.

Fiscal union proposals are not convincing:

  • Enforcement should be key but remains weak.
  • Monitoring and counteracting of “imbalances” is dubious.
  • Subsidiarity is important.

PS: In the FT (October 18), Wolfgang Münchau reaches a similar conclusion albeit from a different starting point: “Better no fiscal union than a flawed one.”

European Monetary Union: A Status Report

In the NZZ (August 7, 2015), René Höltschi provides an excellent overview over the status of European Monetary Union (EMU).


  • EMU combines centralized monetary policy authority with decentralized fiscal powers. This creates the risk that national governments try to free ride.
  • Heterogeneity across Euro Zone member states renders centralized monetary policy difficult. Without national monetary policy instruments, prices and wages need to adjust more in the face of asynchronous business cycles.

Previous solutions:

  • The stability and growth pact was meant to address the first issue. It failed, for political reasons. Markets didn’t impose sufficient discipline either; they anticipated bailouts.
  • Hopes for reduced heterogeneity—as a consequence of EMU—have been shattered.

Reforms so far:

  • During the crisis, member states established rescue funds and agreed on various crisis measures.
  • They pursued a two-pronged strategy. On the one hand, they tried to build on the decentralized approach of the Maastricht treaty. On the other, they aimed at closer integration in the form of banking, fiscal and eventually, political union.
  • Major responsibilities in the area of banking supervision and resolution have been transferred to the European Central Bank. Bail-in procedures have been agreed upon.
  • No major changes occurred in the fiscal policy domain. The “Six-pack” and “Two-pack” measures to strengthen fiscal discipline, coordination and supervision have proved ineffective (e.g., no action against France).

Proposals and discussion:

  • The recent “Five-presidents’ report” distinguishes between short-term (until 2017) and longer-term (until 2025) measures (see below). The report proposes to strengthen the existing framework before moving towards closer integration (Euro treasury, macroeconomic stabilization, fiscal and political union). France and Italy have voiced support.
  • Fiscal union entails a common budget and potentially, a common unemployment insurance. Unity of liability and control would require that fiscal competences are centralized as well. In turn, this would require changes of the European treaties.
  • A further strengthening of banking union, e.g. delegation of banking supervision to a newly created European authority (rather than the European Central Bank), also would require treaty changes.
  • But throughout Europe, there is no desire to delegate powers to “Brussels.”
  • Instead, skeptics like the Bundesbank or the German Council of Economic Experts advocate a bankruptcy procedure for Euro-zone governments: to strengthen discipline and encourage monitoring by financial markets any assistance by the European Stability Mechanism should be preceded by private creditor bail-ins (extensions of maturity, haircuts).
  • Some observers also advocate exit from the Euro zone as an ultima ratio measure. But others argue that this very possibility would undermine the stability of the Euro area.

Five-president’s report:

  • Commissioned in October 2014 by the heads of state and government, the report has been published in June 2015 by presidents Jean-Claude Juncker (European commission), Donald Tusk (European council), Jeroen Dijsselbloem (Euro group), Mario Draghi (European Central Bank) and Martin Schulz (European parliament).
  • In the short term, the report proposes: to improve elements of the previous “six-pack” and “two-pack” reforms, including streamlined coordination and supervision of national fiscal policies;
  • a common backstop for national deposit insurance systems;
  • a European fiscal council serving as watchdog; and
  • independent national agencies to monitor competitiveness.
  • For the longer term, the report proposes: completion of monetary union and fiscal union;
  • macroeconomic stabilization, stopping short of permanent transfers or income equalization schemes; and
  • a Euro zone treasury.
  • Accountability as well as the role of national parliaments and the European parliament in coordinating fiscal policy is to be strengthened. The Euro zone is to be better represented vis-a-vis third parties. Intergovernmental arrangements (for example the European Stability Mechanism) that were created during the crisis are to become integral parts of the EU treaties.

Europe, Monetary Union and Fiscal Union

In a recent blog post, John Cochrane criticizes the common wisdom that, on economic grounds, the Euro was a bad idea for Europe.

He responds to an earlier New York Times article by Greg Mankiw who argued that conventional wisdom: A monetary union requires (1) cross-subsidization/insurance across regions (“fiscal union”) or (2) significant labor mobility across regions. The US has both, Europe does not; Europe therefore needs regional monetary policy instruments and fluctuating exchange rates to dampen the consequences of adverse regional economic shocks.

Cochrane retorts

I am a big euro fan. … I am also a big meter fan. I don’t think each country needs its own measure of length, or to shorten it when local clothiers are having trouble and would like to raise cloth prices.

Cochrane takes aim at the “deeply old-Keynesian” notion that small regions with fewer inhabitants than the Los Angeles metro area (Greece or Ireland say) are exposed to regional “demand” shocks which require regional fiscal or monetary policy responses. In his view, these are small open economies, and demand shocks arise externally.

Cochrane questions the characterization of the US as “fiscal union.”

In the US, we have Federal contributions to social programs such as unemployment insurance. Europe has the common agricultural policy and many other subsidies. We do not have systematic, reliably countercyclical, timely, targeted, and temporary local fiscal stimulus programs. Just how big is the local cyclical variation in state or local level government spending or transfers? (And why does fiscal union matter so much anyway? If you’re a Keynesian, then local borrow and spend fiscal stimulus should be plenty. The union matters only when countries near sovereign default and can’t borrow.) … Yes, both US and Europe have some pretty large cross-subsidies. But most of these are permanent. … Monetary policy has at best short-run effects, so the argument for currency union has to be about local cyclical, recession-related variation in economic fortunes, not permanent transfers.

He also points out that US monetary union far precedes US “fiscal union.” (And he questions the notion that “tight fiscal policy” lies at the root of Greece’s problems and easy monetary policy would have helped.)

Regarding labor mobility, Cochrane emphasizes again that it is cyclical labor mobility which should matter according to the conventional wisdom. He doubts that there are large differences in cyclical labor mobility between the US and Europe.

Not only are the gains from monetary decentralization in Europe small, according to Cochrane, but the benefits from monetary centralization are large, because of gains in credibility.

When Greece and Italy joined the euro, they basically said, defaulting and inflating now will be extremely costly. They were rewarded for the precommitment with very low interest rates. They blew the money, and are now facing the high costs they signed up for. But that just shows how real the precommitment was.

And Cochrane makes the point that policy should address underlying frictions:

The case for separate currencies is to protect the economy from sticky wages, sticky prices, and sticky people. But none of these stickinesses are written in stone. A plausible answer to my question about pre-new deal US is that prices and wages were not sticky (whatever that means) before the era of regulation. Well, that is a loss, and only very imperfectly addressed by artful devaluation of the currency.  Not every block can have its own currency, so local and industry variation within a country remains hobbled by sticky prices, wages, and people. If sticky wages,  prices and people are the central economic problem, we ought to have a lot of policies to unstick them. We do the opposite, and Europe even more so. The very social programs that Greg implicitly praises for fiscal stimulus tie people to location and undermine labor market flexibility.

He concludes:

So I think a lot of the conventional view seems to think implicitly of fairly closed economies, operating in parallel. But Europe’s economies are open. Moreover, the whole point of the eurozone is to open them further. Small open economies are much worse candidates for their own currency.