Revisiting the Economic Case for Fiscal Union in the Euro Area

Departmental Papers, February 20, 2018

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The paper contributes analytically to renewed discussion on the euro area’s institutional setup.
After significant progress during the euro crisis, momentum to complete Europe’s Economic and Monetary Union (EMU) had stalled.
Long-run recommendation: progress along three mutually supporting tracks:
- introduce more fiscal risk sharing, helping to make the sovereign “no bailout” rule credible;
- complementary financial sector reforms to delink sovereigns and banks;
- more effective rules to discourage moral hazard.
Introducing more fiscal union faces myriad legal, technical, operational, and political problems that go beyond economics.
Without decisive progress to foster fiscal risk sharing, EMU will continue to face existential risks.

Fiscal risk sharing is central to making the sovereign “no bailout” rule credible and to improving EMU resilience.
Delinking sovereigns and banks through financial sector reforms is complementary and necessary to reduce sovereign-bank feedback loops.
Stronger rules to discourage moral hazard are required so that financial markets provide incentives for fiscal discipline.
The three tracks are mutually reinforcing: fiscal risk sharing, banking-sovereign separation, and anti-moral-hazard rules together would strengthen incentives and stability.

Advance policies to increase fiscal risk sharing across the euro area to mitigate asymmetric shocks and reinforce the credibility of “no bailout.”
Implement financial sector reforms aimed at breaking sovereign–bank linkages to reduce systemic amplification of sovereign stress.
Strengthen rules and enforcement to discourage moral hazard, ensuring market-based incentives for fiscal discipline.
Recognize and address the legal, technical, operational, and political challenges involved in deeper fiscal integration; policy design must account for non-economic constraints.

Revisiting the Economic Case for Fiscal Union in the Euro Area — Helge Berger, Giovanni Dell'Ariccia, Maurice Obstfeld, February 20, 2018.

45611 Resdp Fiscal Union in Euro Area 022118
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