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

1. 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

2. Do we need a fiscal union? • No • An economically ill-justified judgment • A political mistake

3. 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

4. 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

5. 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

6. Centralization has failed Percent deficits above 3% (original members)

7. Centralization has failed Public debts (% GDP)

8. 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

9. Decentralization works better Bailouts must be strictly forbidden Debt/GDP ratios No bailouts since 1840s Two bailouts

10. 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

11. 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 Creates moral hazard Incentive to fiscal discipline Not a model for Europe in this respect

12. 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 YES NO ✔ Wrong Wrong Wrong

13. real Monetary union needs a central bank Not a fiscal union • 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

14. … 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

15. Not the right time, alas “Whatever it takes”

16. 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