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

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 bailouts No bailouts since 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 ✔ ✔ YES NO ✔

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 union real

… 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