A new paper from International Monetary Fund (IMF) staff argues that advancing fiscal integration would help address a number of gaps in the euro area’s architecture. Alongside the Banking Union, a fiscal union would reduce the incidence and severity of future crises by strengthening fiscal discipline and providing a minimum amount of insurance against deep recessions. While putting in place a fiscal union will take time, providing a roadmap for implementation is viewed as essential to anchor confidence in the euro area’s viability, thereby also supporting current crisis management efforts.
European policymakers have taken important steps to strengthen fiscal and economic governance frameworks. However, vigorous implementation and robust enforcement mechanisms are a prerequisite for greater fiscal integration. With these safeguards in place, according to the paper, a clearer ex ante approach to fiscal discipline and cross-country insurance mechanisms—as opposed to a strategy that relies exclusively on support when crises have already occurred—would further strengthen the architecture and ensure stability of the Economic and Monetary Union.
Essential elements of a fiscal union
The paper sees fiscal integration providing a framework of fiscal discipline and insurance mechanisms that would help contain economic and financial shocks while ensuring better national policies before crises occur:
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Better oversight of national policies and enforcement of rules. With more emphasis on structural fiscal targets and ongoing reforms to the governance framework, the design of fiscal policy has improved. However, going forward, reinstating fiscal discipline and reviving market discipline may require stronger involvement of the center in national fiscal decisions and clarification of bailout rules.
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Increasing risk-sharing. Ex ante risk-sharing reduces the need for costly support afterwards. So, provided there is better disciplining of national fiscal policies, all euro area countries would benefit from cross-country fiscal insurance mechanisms. There are a number of options available, including setting up a euro area-wide rainy day fund, a common unemployment insurance scheme, or a budget for the euro area.
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Borrowing at the centre. In the long term, when the appropriate governance structures are in place, borrowing by the centre—backed by its own revenues—could help finance risk-sharing vehicles, and reduce the potential for large portfolio shifts between sovereigns by providing a safe asset.
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A fiscal backstop for euro area banks. European policymakers have made important progress towards a banking union. Current steps to establish a Single Supervisory Mechanism and a Single Resolution Mechanism should be complemented by a firm and early commitment to establish an adequate backstop to anchor confidence in the banking system. While some of the insurance against banking accidents should be funded by the industry, a common backstop for the recapitalisation, resolution, and deposit insurance would contribute to reducing the risk of contagion.
While the first three of these elements would help build a more stable union in the medium to long term, the final one is time sensitive, and thereby requires immediate attention.
Political backing for a clear roadmap that outlines the contours of a fiscal union is critical. While advancing fiscal integration will naturally take time, historical experience shows that effective crisis management has often gone hand in hand with far-reaching long-term reforms, including transferring some fiscal responsibilities to the central level.
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Further reporting Eurozone governments must give up more power to avoid another crisis, say IMF economists © Telegraph
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