The future of euro area: do we need a fully-fledged fiscal

union?

Charles Wyplosz

The Graduate Institute, Geneva

Council for Budget Responsibility of Slovakia

Seminar on Macroeconomic and Fiscal Issues

Bratislava, May 5, 2014

Do we need a fiscal union?

• No

• An economically ill-justified judgment

• A political mistake

The economic misjudgment

• Reasoning Crisis has shown the need for mutual support

• Fiscal discipline limits use of national fiscal policies• Some federal support needed to make up

More generally, monetary union needs political union• This includes banking union and fiscal union• Remove ECB from potential transfers• Provide resources for bank resolution

Wrong

Wrong

Wrong

Wrong

Wrong

Fiscal discipline

• Fiscal discipline absolutely needed within monetary union Moral hazard

• Vis a vis other member countries• Vis a vis ECB

Contagion risk

• Solution: centralization Common rule

Enforcement by Commission and Council

The flaws of centralization

• Different countries require different rules Presidential vs. parliamentary

Single majority vs. coalition governments

• Fiscal authority is national Central interference conflicts with democratic

principles

“Brussels” against voters

Result: disconnect between sovereignty and enforcement

Centralization has failed

Percent deficits above 3% (original members)

Centralization has failed

Public debts (% GDP)

The unspoken alternative: decentralization

• A great example: US states Sovereign in fiscal policy matters

All but one have rules• Own enforcement mechanisms (State Supreme

Courts)

• Break occurred in 1840s No Treaty, no law

Just no bailout decision by US Congress

Then each state invented its own rules

Decentralization works better

Debt/GDP ratios

Two bailoutsNo bailoutssince 1840s

Bailouts must be strictly forbidden

Implications

• Fiscal Union seen as necessary for bailouts

Bailouts ought to be strictly forbidden

• Fiscal Union seen as necessary to deal with cyclical disturbances

Indeed the US Federal Model

But: the equivalence principle

The equivalence principle

• Equivalence: when in recession Insurance: receive support from Federal level

• Pay back in providing insurance to other countries

Borrow to spend, reimburse later• Can easily be done when fiscally disciplined

• No need for an insurance system• The US

Old fashioned state budget rules prevent borrowing

Insurance

Not a model for Europe in this respect

Creates moral hazard

Incentive to fiscal discipline

The economic misjudgment

• Reasoning Crisis has shown the need for mutual support

• Fiscal discipline limits use of national fiscal policies• Some federal support needed to make up

More generally, monetary union needs political union• This includes banking union and fiscal union• Remove ECB from potential transfers• Provide resources for bank resolution

Wrong

Wrong

Wrong

Wrong

Wrong

✔✔

YESNO

✔

Monetary union needs a central bank

• No bailout but lender in last resort To banks

Not to government (no-bailout clause is crucial)

• Bailing out banks SSM, half done

SRM, quarter done• Some funds are OK, but will never be enough

Transfers across countries?• Not if clear rules of engagement

Not a fiscal unionreal

… and a political mistake

• Fiscal Union requires sovereignty transfers Some common spending

Some taxing power

• No opposition in principle (US of Europe) But requires voters’ consent

Not the right time, alas

“Whatever it takes”

Conclusion

• One day, we will have a fiscal union• Not now

Too politically dangerous, not needed

• Waste of time, better things to do SSM and SRM

A real central bank

Legacy debts