Towards a stronger euro area: Sharing risk and sovereignty

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.COM Ltd.

Greek solidarity march. Brussels, June 2015. [Samuel Morgan]

What would a proposed “European Fiscal Union” look like, and would it be successful? ask Jörg Haas and Katharina Gnath.

Jörg Haas is a Research Fellow at the Jacques Delors Institute in Berlin and Katharina Gnath is a Senior Project Manager in the Europe’s Future programme at the Bertelsmann Foundation. 

One notion of a fiscal union is built on the concept of sovereignty-sharing. The idea is to provide the European level with more intervention powers so it can impose effective discipline on national budgets. Without a doubt, stringent fiscal rules and supervision can support the stability of a currency union. A country with low levels of debt has more room for manoeuvre in the event of a crisis, as it can increase expenditures and thus bolster internal demand.

However, it is unlikely that sovereignty-sharing alone will create enough stability for the euro area. Practical experience has shown that enforcing European budget rules is very difficult in the face of national interests, irrespective of the formal powers EU institutions wield. Moreover, even 19 countries with a stable government debt ratio do not necessarily constitute a stable monetary union.

Without a monetary policy of their own, euro area countries can only use fiscal policy to combat a crisis. At the same time, they are subjected to far greater shocks and contagion effects than they would experience without monetary union. Ireland and Spain found out to their cost that their adherence to European budgetary rules was of little importance when the crisis hit. More encompassing rules are now in place, but it is in their very nature that they have been designed to fight the last crisis, not to prevent the next one.

This is where a second notion of a fiscal union can make a difference. It is based on the idea of risk-sharing and mutual support. One instrument could be common debt obligations (“Eurobills”) that would partially replace national debt. This would prevent self-fulfilling insolvencies, vicious cycles where even initially unfounded doubts about a country’s solvency can lead to higher interest rates on its debts and thus to an actual deterioration of its fiscal position.

Contrary to an often-held argument that Eurobills create moral hazard, they could in fact strengthen the disciplining effect of the markets on government expenditure as long as not all public debt is issued jointly. They would provide banks with a sufficient supply of safe assets which do not depend on the solvency of a single vulnerable sovereign. Consequently, the insolvency of over-indebted countries would become a credible option, since it would no longer lead to the collapse of a nation’s entire national financial system, and thus to politically and socially unacceptable costs.

So-called “automatic stabilisers” that would temporarily redistribute money from booming countries to those in a recession could be another way of sharing risk in the euro area. There are several options available, such as a common unemployment insurance scheme or a stabilisation mechanism based on output gaps. Automatic stabilisers would synchronise the euro area’s business cycles and thus help prevent the emergence of dangerous imbalances in the euro area. Since all countries experience economic ups and downs, they could be calibrated in a way that results in low or no net transfers in the medium term.

However, a fiscal union is no more than a building block for the stabilisation of the monetary union, albeit an important one. A glance at the United States, which is often cited as the model of a functioning monetary union, reveals that risks are shared not only via fiscal policy, but also via the credit and financial markets. Any fiscal union would thus have to be accompanied by stronger private risk-sharing. Reaching a political agreement on such a reform package will not be easy. Different national preferences, mistrust between euro area member states, and a widespread reluctance to change the European Treaties are just some of the obstacles that European policy-makers face.

Should Europe wait until the member states have once again developed mutual trust and respect before it embarks on reforms? This path sounds promising only at first sight. In fact, the alternative to a substantial reform of the euro area is not the continuation of a more or less stable status quo, but the regular recurrence of crises. Under the current framework, macroeconomic imbalances are part of the common currency. And while fiscal union might have some distributional effects, their cost is likely to be much lower than that of ongoing instability.

The members of the euro area should now stop being defensive and use the opportunities presented by the Five Presidents’ Report that initiated a new round of reforms. The guiding question should no longer be “What do we want to prevent?” It ought to be “What do we want to achieve and what can we give in return?” As far as France is concerned this will mean fleshing out the recent proposals for a European finance minister. And for Germany, it will mean specifying how much sovereignty-sharing and economic convergence would be needed in order to agree to a greater degree of risk-sharing in the monetary union. 

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