End of fiscal sovereignty in Europe
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So why isn't a federal system equally fragile? Because it has two key safety valves: the central government's ability to run deficits and act decisively, and labor mobility.
The EU does not have a robust centralized fiscal structure with a counter-cyclical mandate. And labor mobility, a long-run goal in the EU, is constrained by language, laws, and diverse regulatory regimes. In addition, state bonds are not treated as equals, and the markets penalize profligate states. If the EU wants a monetary union in which sovereign debt is relatively homogenous in terms of risk, fiscal discipline must be similarly homogenous. But that also means it will need a more robust mechanism for counter-cyclical responses to shocks.
EU leaders recently stated their intention to revisit the Maastricht structure, which in principle is a good idea. They may take the route of adapting the Maastricht rules to allow for more inter-temporal flexibility at the national level. But that approach would be complicated. One would need a sophisticated capability for monitoring and enforcing fiscal policy and sovereign debt - or else end up with a repeat of the current situation.
A better long-term solution is a central EU fiscal capacity that accumulates the resources to respond to shocks during growth periods. One could think of it as a stabilization tax that becomes negative in downturns. But such a move does involve some degree of fiscal centralization. And it probably would require the EU to issue sovereign debt. It is unclear whether there is the political will to do all that.
But a step in the right direction could be taken by partial fiscal centralization with a limited counter-cyclical mandate. That would enable effective enforcement of fiscal discipline at the national level and provide the euro with the fiscal discipline it needs to survive.
When the eurozone was created, it was widely understood that fiscal discipline was a crucial underpinning. The current crisis vividly underscores the point. The challenge now is to achieve a combination of discipline and flexibility that protects the collective interest. That will involve a loss of full fiscal sovereignty, but facing up to that reality is required to sustain the monetary union.
The author is the 2001 Nobel Laureate in Economics and professor emeritus, Stanford University. Project Syndicate
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