Toward A Fiscal Union for the Euro Area

Abstract

Risk sharing within a common currency area. Crosscountry risk sharing arrangements take on added importance in a common currency area. Within a currency union, countries cannot use monetary policy to respond to country-specific shocks, since the common monetary policy reflects the (weighted) fundamentals of all of the members and not that of any one country. Likewise, wage and price rigidities and limited labor mobility across countries, whether due to legal constraints like the immobility of pension benefits, or cultural factors, like language differences, can reduce the ability of a country to adjust to country-specific shocks. In principle, domestic fiscal policies are a natural tool in a currency union to manage country-specific shocks. But their scope to act counter-cyclically can sometimes be limited, as was seen in the euro area during the Great Recession: credit markets froze up, making it difficult both for sovereigns and private agents to use borrowing to smooth consumption. To some extent, liquidity provision by the European Central Bank and official crosscountry flows (through the TARGET2 settlement mechanism) helped fill the gap left by private credit markets (Cecchetti, McCauley, and McGuire, 2012). But crosscountry fiscal arrangements might be a powerful additional instrument to support risk sharing in these circumstances.

Revenue for EMU: A Contribution to the Debate on Fiscal Union

“…Supported by back-of-the envelope-calculations, some proponents of a stabilisation fund for the euro area propose a common fund of about 1-2 % of euro area GDP (see e.g. Wolff, 2012;Trésor, 2013;Allard et al, 2013). Allard et al (ibid.…”

“…On behalf of the International Monetary Fund a staff discussion note (Allard et al, 2013) has identified four essential "minimal elements for a fiscal union" in order to enhance the resilience of the monetary union against future crises: first, better oversight and incentives conducive to prudent fiscal policy making at the national level are called for, basically requiring a thorough and systematic application of the European fiscal governance reforms taken in the course of the crisis. Next, some degree of centralised fiscal risk-sharing and public goods provision is advocated conditional on a framework providing better oversight and incentives.…”

Euro Area unemployment insurance at the time of zero nominal interest rates

“…Despite recent progress with the banking and capital markets unions, financial intermediation in Europe is primarily bank based and financial markets remain fragmented along national lines. As a result of this fragmentation, the level of private risk-sharing compared to federations like the United States, Canada or Germany tends to be considerably lower and biased towards domestic credit, rather than capital flows (Allard et al, 2013). Moreover, the risk sharing through the bank lending channel tends to break down in period of crisis, exactly when needed the most (Furceri and Zdzienicka, 2015).…”

“…Furthermore, the current system of European fiscal rules does not provide strong incentives to cut deficits or, as in case of Ireland and Spain, to sustain large surpluses in good times (Dullien, 2017). According to Allard et al (2013), with pay-outs limited to asymmetric temporary shocks to GDP, a euro area rainy-day stabilisation fund created in 1999 could have raised the overall level of income shock smoothing to 80% (roughly, the level in Germany), at the cost of annual contributions ranging from 1.5 to 2.5% of euro area GNP. Moreover, in the case of common negative shocks, the stabilisation properties of the unemployment insurance scheme may usefully be enhanced by the ability to issue debt.…”

Reconciling Insurance with Market Discipline: A Blueprint for a European Fiscal Union

“…Cottarelli (2013) Allard et al (2013Allard et al ( , 2015 suggest "minimal elements for a fiscal union in the euro area" to make a future crisis less severe: (i) a better oversight of national fiscal policies and enforcement of fiscal rules, (ii) some system of temporary transfers or joint provision of common public goods or services to increase fiscal risk sharing (subject to strong oversight and enforcement of fiscal discipline), (iii) a credible pan-euro area fiscal backstop for the banking sector and (iv) common borrowing to finance greater risk sharing and a stronger backstop and the provision of a common safe asset. Corsetti et al (2014) propose "New Institutions and New Policies for a Workable Eurozone".…”