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One of the main lessons of the Global Crisis is that to preserve full financial integration and financial stability the eurozone needs to build elements of a common fiscal policy.
Realising such a deep transformation would require Treaty changes and constitutional reforms in member states, something that does not appear politically feasible in the near term. Yet, at some point the eurozone will have to grapple with these issues, and the more thoroughly they are discussed, the sooner they will fill the political agenda.
Priorities
Unlike for the US and other federations that achieved integration at an early stage of state development, all eurozone countries already have large (arguably too large) government spending and taxation. Under any foreseeable scenario, most of these government functions and capacities will have to remain national. The fiscal union should have a few main purposes and priorities, namely to complement the monetary union in two main ways.
The first point was emphasised also in the Five Presidents’ Report. The eurozone needs a policy tool with which to manage aggregate demand and stabilisation policies during large Eurozone recessions. [...]
The second point is instead much more controversial. The Five Presidents’ Report explicitly rules it out, with the argument that the ESM already performs this function. [...]
Concluding remarks
The arrangement described above entails two obvious politically obstacles, that may be difficult to overcome at least in the near term. First, countries have to give up sovereignty over a fraction of their tax revenues.
It is important to stress, however, that the sacrifice needs not be large in terms of size of yearly revenue. Stability bonds don’t need to be a large fraction of aggregate GDP in order to insure adequate fiscal stabilisation or to provide risk sharing during emergencies. What is essential is the long time horizon, the pledge to transfer national revenue to the Eurozone should extend for a long period of time. A pledge over several decades can provide adequate backing, even if the yearly transfer is relatively small, provided that the arrangement is credible and lasting. In other words, setting up a fiscal union along these lines entails an important element of irreversibility. Without the expectation of irreversibility, the pledge would lack credibility and the arrangement would fail. But the expectation of irreversibility is at the core of the single currency, and it is meant to distinguish it from a fixed exchange rate regime.
The second political obstacle is that the benefits of this arrangement may not be perceived as symmetric. The weaker and highly indebted countries are more likely to lose market access or to be involved in a sudden stop. The benefits of stability bonds are likely to be greater for them than for the stronger member states. On the other hand, the arrangement also entails a greater expected loss of sovereignty for the weaker or highly indebted member states who are more likely to incur in the veto of the Fiscal Institute over their national budgets. In other words, there is an implicit exchange; in order to enjoy the potential benefits of this arrangements, the weaker member states have to accept a temporary loss of sovereignty if they don’t meet the sustainability requirements established ex-ante. This, of course, is a greater loss of sovereignty than that.