polish euro

EKONOMIA I PRAWO. ECONOMICS AND LAW Volume 16, Issue 4, December 2017 p-ISSN 1898-2255, e-ISSN 2392-1625 www.economicsandlaw.pl © 2017 Nicolaus Copernicus Universi!. All rights reserved. cbyd Designing a !scal union for the euro area MAGDALENA KAKOL Maria Curie-Skłodowska Universi$, Facul$ of Economics, Department of World Economy and European Integra%on, Plac Marii Curie-Skłodowskiej 5, 20-031 Lublin, Poland 􀇰 mkakol@hektor.umcs.lublin.pl Abs&act Mo!va!on: Fiscal integra%on cons%tutes an important adjustment mechanism to cope with asymme&ic shocks within a monetary union which does not ful!l many criteria of an op%mal currency area. As is currently the case in the euro area, na%onal governments implement discre%onary !scal policy to &y to cope with the adverse economic shocks themselves and to &y to stabilise income which leads to high budget de!cits and public indebtedness in many euro area coun&ies. While conduc%ng !scal policy at suprana %onal level and !scal &ansfers within EMU would allow for su'cient cross-coun&y risk sharing and con&ibute to macroeconomic stabili$ of the whole euro area. Aim: (e aim of the paper is to give economic ra%onale and explain the signi!cance of !scal union for the e)ec%ve func%oning of a common currency area, and especially its macroeconomic stabili$ as well as to present various forms of !scal integra%on and to assess the possibili$ of their in&oduc%on within the euro area taking into account the current degree of economic integra%on, principles of conduc%ng macroeconomic policy and its outcomes, the actual situa%on in the !eld of public !nances and poli%cal circumstances in EMU and its member coun&ies. Results: (e greatest poten%al for macroeconomic stabili$*— both in terms of asymme &ic shocks, as well as these a)ec%ng the en%re euro area*— ensures the establishment of a large federal Eurozone budget. However, in a situa%on of a lack of poli%cal will to move forward into a poli%cal union, the approach to ensure !scal stabilisa%on should include: crea%ng even a small euro area-wide budget and the common Minis&y of Finance, in&oducing a European unemployment (re-)insurance scheme with further harmoniza %on of labour markets, equipping the banking union with a !scal backstop as well as making na%onal !scal policies more stabilising and avoiding to impose self-defea%ng !scal adjustments on crisis coun&ies. ORIGINAL ARTICLE received 13.06.2017; revised 01.12.2017; accepted 31.12.2017 Cita%on: Kakol, M. (2017). Designing a !scal union for the euro area. Ekonomia i Prawo. Ecomomics and Law, 16(4): 413–432. doi:10.12775/EiP.2017.029. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 414 Keywords: EMU; !scal union; euro area budget JEL: E61; E62; E63; F36; F42; F45 1. In!oduc"on !e euro area was provided with the competence to conduct the single monetary policy while "scal policy was le# to the member coun$ies. !e lack of su%cient real convergence of their economies has been neglected and, in the absence of e&ec've adjustment ins$uments, a few Eurozone members were forced to use "scal policy to counter the o#en pro-cyclical impact of monetary policy, even despite the Maas$icht criteria and the Stabili( and Growth Pact rules. !e "nancial and economic crisis (2008/2009) revealed cri'cal design failures in the EMU architecture. Its main outcome is the huge public indebtedness of many euro area coun$ies. !e synchronisa'on of economic cycles of the periphery and the core coun$ies (and also within the group of peripheral coun$ies) fell markedly a#er the crisis (Belke et al., 2016) and as a result they are exposed to a greater extent to asymme$ic shocks. A range of reforms that were supposed to s$engthen the resilience of EMU: the overhaul of the "scal governance )amework (the six-pack and two-pack legisla'on, the Fiscal Compact), the macroeconomic imbalance procedure, the crea'on of crisis resolu'on mechanisms (the European Stabili( Mechanism and the Ou$ight Monetary Transac'ons), the establishment of the "rst pillars of a banking union*— proved to be insu%cient to ensure the macroeconomic stabili( of the euro area and its member coun$ies. In these circumstances, a debate on a new common "scal shock absorbing capaci( was started that would allow for su%cient cross-coun- $y risk sharing and con$ibute to macroeconomic stabili( of the whole euro area. !e crea'on of a "scal solidari( ins$ument was advocated by representa 'ves of many EU ins'tu'ons: in the ‘Four Presidents’ Report (Van Rompuy et al., 2012); the European Commission’s Blueprint for a deep and genuine EMU (European Commission, 2012), the ‘Five Presidents’ Report (Juncker et al., 2015) and at the beginning of 2017 the European Parliament ‘gave green light’ for in$oducing the common euro area budget. !e aim of the paper is to give economic ra'onale and explain the signi"- cance of "scal union for the e&ec've func'oning of a common currency area, and especially its macroeconomic stabili( as well as to present various forms of "scal integra'on and to assess the possibili( of their in$oduc'on within the euro area taking into account the current degree of economic integra'on, principles of conduc'ng macroeconomic policy and its outcomes, the actual situa 'on in the "eld of public "nances and poli'cal circumstances in EMU and its member coun$ies. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 415 2. Research methodology When discussing economic ra!onale and poten!al forms of "scal integra!on within Eurozone, the theory of "scal federalism should be used as guidance, although the Op!mal Currency Area (OCA) theory as well as di#erent approaches of main economic schools to the role of "scal policy in an economy (including its stabilisa!on func!on) could also be helpful. $e paper has been focused on selec!ng and highligh!ng the most important arguments in the ongoing economic debate in favour of in%oducing a "scal union in the euro area &om a theore!cal perspec!ve and based on empirical data. $e following research methods were used: a cri!cal assessment of the scien- !"c acquis related to "scal integra!on incorporated in various theories of economics, a compara!ve analysis of literature, EU documents and principles concerning the func!oning of EMU as well as an analysis of empirical studies and sta!s!cal data on public "nances and "scal policies of the euro area member coun%ies: Eurostat (2017), Ameco (2017), and IMF (2017a, 2017b) databases. 3. !eore"cal approach to #scal integra"on within the euro area $ere is no single and clear-cut de"ni!on of "scal federalism (or "scal union) in economic literature. As stated by Bordo et al. (2013, p. 451), ‘the concept of a "scal union entails "scal federalism among its members, which could be either sub-na!onal (sub-cen%al or regional) poli!cal units or na!on states’. Dabrowski (2015, p. 7) underlines that such federalism (and "scal union) involves a par!al %ansfer of "scal resources and competences in the "eld of "scal policy including "scal management &om the na!onal to suprana!onal level. Interpreta !ons of terms: ‘"scal federalism’, ‘"scal union’ and ‘"scal integra!on’ range &om a set of common "scal rules to the crea!on of a fully federal government with tax and spending powers ($irion, 2017, p. 3). $ere are also more complex de"ni!ons of "scal federalism and "scal integra !on, the authors of which s%ess that this is a tedious process composed of many elements. For Bordo et al. (2013, p. 451), who base their de"ni!on on the "ndings of Sorens (2008), only adding the last condi!on, perfect "scal federalism consists of the "ve elements: (1) autonomy of sub-cen%al poli!cal en!!es to decide taxes and expenditures; (2) hard budget cons%aints for local governments including a no-bailout rule; (3) existence of a common market based on &ee %ade and mobili' within the "scal union which ensures compe!- !on among sub-cen%al governments; (4) ins!tu!onalisa!on of "scal federalism system in a set of rules, and (5) common currency shared by the sub-cen%al and the cen%al "scal authori!es as they are not only par!cipants of the common market but also of the same monetary union. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 416 According to Oates (1999, pp. 1121–1122), the theory of !scal federalism should help us assign di"erent func#ons and ins$uments of !scal policy to an appropriate government level in order to increase its e"ec#veness and economic welfare. %e aim of the cen$al government and a federal budget is threefold (Bénassy-Quéré et al., 2016, p. 4): (1) to !nance those public goods that are common to all regions or states cons#tu#ng a federa#on (e.g. defence, diplomacy, R&D, in&as$ucture), (2) to carry out $ansfers between regions to compensate geographical or historical disadvantages, and to maintain economic and social cohesion within a federal state, (3) to ensure macroeconomic stabilisa#on by smoothing out business 'uctua#ons in line with the GDP $end at a na#onal level and across the regions. %e la(er task cannot usually be realised by local budgets as they are o)en cons$ained by #ght balanced-budget rules (including a no-bailout rule by the federal government to reduce moral hazard, i.e. the natural tendency of local authori#es to increase debt if there are no !scal limita#ons). %erefore the main purpose of lower levels of government should be provision of public goods whose produc#on and consump#on is limited to their own jurisdic#ons (Oates, 1999, p. 1122). Within a current EU governance &amework the general budget is very small (around 1% of EU GNI and 2% of public expenditures of member states) and en#rely devoted to the !rst two objec#ves of !scal policy. It cannot perform stabilisa#on func#ons not only because of its modest size but also as a result of the absolute principle of budget balance. Meanwhile, of the three main func- #ons of !scal policy (provision of public goods, redis$ibu#on and stabilisa#on) only the last fully jus#!es conduc#ng this policy at the EMU level (see Bénassy- Quéré et. al. (2016, p. 2)). At the #me being, in the euro area (i.e. a monetary union with the single monetary policy) the ECB plays a stabilising role against shocks a"ec#ng the Eurozone as a whole (e.g. it cuts interest rates in downturns and raises them in upturns), but in the case of shocks a"ec#ng individual member coun$ies there is ample room to address them through na#onal !scal policies. As unsustainable !scal policy in one or a few member states could destabilise the en#re monetary union due to direct and indirect demand e"ects with an impact on euro area-wide in'a#on it should be subject to !scal discipline and su*cient coordina#on at the cen$al level. However, even if these requirements are formally met+— unless the common currency area is to a large extent op#mal (including high business cycle synchronisa#on)+— there is a danger of pro-cyclicali, of !scal policy performed at na#onal level (both for certain member coun$ies as well as for the whole euro area). Empirical data on the outcomes of domes#c !scal policies in the Eurozone so far seem to con!rm this (see e.g. Huart (2013, pp. 73–88); Nerlich & Reuter (2015)). %at is why most scholars agree that in federa#ons the macroeconomic stabilisa #on should be implemented at the cen$al level. %e stabilisa#on of economic ac#vi, via !scal policy relies on suppor#ng the economy through higher expenditures or lower taxes in a downturn, and reducing the budget de!cit in an upturn. %is can be realised by two main channels: (1) automa#c stabilisEKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 417 ers that smooth economic ac!vi" through the automa!c response of taxes and #ansfer systems to the business cycle; (2) discre!onary $scal policy measures, i.e. changes in government expenditures and less o%en taxes as a result of $scal authori!es’ decisions. However, most evidence points to a signi$cant countercyclical role of automa!c stabilisers rather than of discre!onary $scal measures (Bankowski & Ferdinandusse, 2017, p. 16). In the euro area automa!c stabilisers are larger than in the US (they smooth 38.5% of a propor!onal income shock in the EU on average while in the US only 34%), but their e'ects vary greatly between member coun#ies ((om around 30% in PIGS coun#ies to over 50% in Belgium) (Dolls et al., 2012). )ough $scal stabilisers operate well in case of small shocks, the lack of ‘regional’ governments’ con#ol over the currency in which their debt is issued may cause problems during a severe crisis, especially for coun#ies that accumulated large imbalances and external debt. )e most vulnerable member states may $nd it di*cult to $nance themselves in $nancial markets and increasing sovereign debt yields can force them to cut automa!c stabilisers which leads to further recessionary pressures (De Grauwe, 2016, p. 152; )irion, 2017, p. 12). )erefore, in some situa!ons the discre!onary $scal policy is jus!$ed (e.g. during large economic shocks leading to crises) or even considered as being the most e'ec!ve way to stabilise the economy, e.g. when monetary policy is cons#ained by the zero lower bound. In such circumstances government spending mul!plier is par!cularly high (Eggertsson, 2011; European Commission, 2016, pp. 137, 153) and temporary expenditure increases, as well as an appropriate revenue-neu#al combina!on of changes in taxes, could deliver s!mulus to the economy and replicate the e'ects of nega!ve nominal interest rates (Correia, et. al., 2013). )e fact that governments can become credit-cons#ained and may be forced to cut automa!c stabilisers or discre!onary spending during severe economic shocks is the ra!onale for a suprana!onal $scal-#ansfer ins#ument (at least against the largest shocks) in the Eurozone ()irion, 2017, pp. 12–13). According to the theory of op!mum currency areas (OCAs) a system of federal $scal #ansfers across a currency union’s regions reduces the costs of monetary uni$ca!on resul!ng (om the loss of na!onal monetary policy and nominal exchange-rate adjustment mechanism when a coun#y is a'ected by an adverse coun#y-speci$c shock (Kenen, 1969). Other adjustment mechanisms that allow for allevia!ng the consequences of asymme#ic shocks in a monetary union are market-based and include the high mobili" of labour and capital, the +exibili " of prices and wages as well as $nancial market integra!on (Mundell, 1961 and 1973; McKinnon, 1963). Mundell (1973), highlights that private risk-sharing through the su*ciently integrated capital and credit markets could provide adequate insurance against shocks when economic cycles are not synchronised, which makes a $scal union unnecessary. As com$rmed by Eichengreen (1991, p. 17) interregional $scal #ansfers $nanced through federal taxes are jus!$able ‘only if insurance cannot be provided by the market’. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 418 In federa!ons macroeconomic stabilisa!on via the federal budget is achieved both at sub-na!onal level (through temporary net "ansfers) as well as at the coun"y level (through federal borrowing) (Bénassy-Quéré et al., 2016, p. 5). One of the most prominent advantages of a cen"alised #scal system is that it allows for economies of scale to pursue stabilisa!on objec!ves because the cen- "al government can usually borrow $om the market at lower costs (Bordo et. al., 2013, p. 455; %irion, 2017, p. 11). However, besides #scal risk-sharing, an important role in shock absorp!on is o&en played by market adjustment mechanisms including well integrated and developed #nancial markets. While private capital markets ensure diversi#ca!on of #nancial por'olios and hence allow households or governments to diversify their income s"eams, cross-border credit markets facilitate saving in good !mes and borrowing in !mes of crisis not only to coun"ies but also to public and private agents at sub-na!onal level (Allard et. al., 2013, p. 14). Recent studies (Allard & Bluedorn, 2016; Bluedorn et al., 2013) show that in 3 large federal states(— Canada, Germany, and the US(— around 80% of income shocks to sub-na!onal territorial units are smoothed mainly via private credit and capital markets (smoothing about 50–70% of shocks) and to a lesser extent via public "ansfers $om the center to sub-na!onal components (between 10–30%). By con"ast, income shocks to Eurozone coun"ies are only about 40% smoothed with #scal risk-sharing (obtained through the EU budget) found to be nearly zero. %e most s"iking di)erence between the US and EMU is the very low degree of risk-sharing via capital markets (i.e. interna!onal factor income) in EMU compared to the US (between 0–10% in the Eurozone vs. almost 40% in the US) (Kalemli-Ozcan et al., 2014). Allevia!ng of nega!ve shocks in the euro area occurs mainly through the credit channel: cross-border saving and borrowing. However, this channel is par!cularly $agile(— tends to amplify shocks rather than smooth them (%irion, 2017, p. 13). It breaks down in periods of #nancial crises, when risk sharing is most needed, as interna !onal credit markets become unwilling to grant loans, and this is especially the case in the euro area periphery (Furceri & Zdzienicka, 2013; Kalemli-Ozcan et. al., 2014; Alcidi & %irion, 2016). In this context the idea to create the fully-*edged European banking union (with a common system of deposit reinsurance(— i.e. some form of #scal union) as well as the European capital markets union should be widely supported. Unfortunately, the current European Commission proposals concerning the la+er ins!tu!on are far too !mid so as we could see much higher level of market risk-sharing in the Eurozone in the nearest future. Necessary integra!on of capital markets will require major steps in the areas of harmoniza!on of accoun!ng, insolvency, "ansparency and taxa!on (Véron & Wol), 2015). %ough for some scholars (e.g. Gros & Belke (2015)) risk-sharing through a well func!oning banking union and a capital markets union may be su,cient to absorb losses $om most #nancial shocks, for others (e.g. Farhi & Werning (2017)) even complete #nancial integra!on EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 419 must be supplemented by at least a minimum degree of !scal insurance as it can be perceived by the market as a catalyst for private risk-sharing. "irion (2017, p. 11), emphasises that a perfectly designed !scal capaci# (a system of !scal risk-sharing) for the euro area should allow to achieve three kinds of stabilisa$on: (1) of asymme%ic shocks within EMU; (2) of the aggregate EMU business cycle (inter-temporal EMU-wide stabilisa$on), and (3) of domes$c business cycles. However, gaining all three at the same $me is an ex%emely di&cult task. For instance, stabilising asymme%ic shocks and a coun%y’s output gap can be reconciled only if the EMU output gap is constantly zero (coun%y-speci!c shocks are randomly dis%ibuted around a constant Eurozone-wide growth tend). If it is not the case full !scal risk-sharing could generate pro-cyclical !scal policies at the coun%y level as coun%ies undergoing a downturn but doing rela$vely be'er than their neighbours during an euro area-wide recession would be forced to increase their net con%ibu$on. From this perspec$ve, aiming at perfect !scal risk-sharing might not be the best solu$on as regards na$onal macroeconomic stabili#. "e rules of conduc$ng !scal policy in the euro area have been greatly in- (uenced by the theory of economics and its evolu$on. While Keynesianism recognizes budget de!cit as a necessary tool for stabilising economic growth, the new classical macroeconomics accepts a cyclical de!cit (%iggered by ac$vi# of automa$c stabilisers) as a ma'er of necessi#, but s%ongly opposes s%uctural de!cits and discre$onary policy. In recent years, however, di)erent approaches of many schools of economic thought to the stabilisa$on role of !scal policy in an economy have been reconciled to some extent and the concept of !scal sustainabili# has been gaining in populari#. It emphasises that ensuring safe# of state !nances is of no less importance than the needs of economic stabilisa- $on (aiming at economic equilibrium and GDP growth). A sustainable !scal policy can be de!ned as a policy leading to the ra$o of debt to GDP eventually converging back to its ini$al level (Blanchard et. al, 1990, p. 11). Alesina (1994), s%esses that maintaining !scal sustainabili# requires relying on automa$c stabilisers *— a cyclical de!cit is permissible because it gets reset during a business cycle whereas a s%uctural de!cit should be reduced to zero at the level of poten $al product (or be at a very low level on the assump$on that public indebtedness is small). Permanent growth in the s%uctural de!cit means a con$nuous increase in sovereign debt, and a rise in its opera$ng costs is becoming pro-recessionary. "is reasoning was included in the rules of the Stabili# and Growth Pact according to which the assessment of !scal policy in the euro area should be based on the size of s%uctural balance. "e euro area coun%ies are supposed to pursue a rather passive !scal policy (based on automa$c stabilisers) within a business cycle and the s%uctural de!cit should not exceed 0.5–1.0% of GDP. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 420 4. Empirical evidence on the outcomes of !scal policies in the Eurozone concerning macroeconomic and !scal stabilisa"on !e exis"ng #scal policy $amework does not ensure either macroeconomic or #scal stabili% for many Eurozone coun&ies, especially in hard economic "mes. Fiscal stabilisa"on outcomes of na"onal policies in the Eurozone were gathered in table 1. In 1999–2016 as many as 10 out of 19 euro area coun&ies maintained an average general government de#cit of over 3% of GDP, with Greece, Portugal and France accoun"ng for the highest number of breaches of the budget criterion. During that period Luxembourg, Estonia and Finland were most concerned about budgetary discipline among the Eurozone coun- &ies. While in the #rst years of the euro area func"oning member coun&ies managed to slightly reduce public debt levels ($om 70.6% to 64.9% of GDP in 1999–2007 for EA–19 on average), the 2008/2009 #nancial and economic crisis and the use of #scal policy to counteract its nega"ve outcomes have led to a large increase in sovereign indebtedness in rela"on to GDP, especially in Greece and Portugal. In 2016 compared to 1999 public debt levels in rela- "on to GDP were higher in 17 euro area coun&ies and lower than their ini"al level only in two of them (Belgium and Malta). However, four large coun&ies (Italy, Germany, France and Spain) have the greatest in'uence on #scal stabilisa "on of the en"re EMU with the combined share of almost 80% of total EA public debt in 2016. In three of these coun&ies (excluding Germany) the level of sovereign indebtedness exceeded or was approaching 100% of GDP in 2016. !e dangerous phenomenon is not only the high level of public debt, but also its growing varia"on between member coun&ies measured by standard devia"on, even despite declining diversi% in terms of budget de#cits in 1999–2016. !is also con&ibutes to large di(erences in government bond yield spreads between the Eurozone coun&ies (table 1). Unfortunately, empirical research also fails to con#rm the posi"ve impact of #scal policy in the euro area on the macroeconomic stabili% of the Eurozone as a whole as well as stabili% of certain member coun&ies, i.e. its counter-cyclical impact on the economy. Alcidi & !irion (2016, pp. 4–5) examined pro-cyclicali% of #scal policy at the euro area level and across member coun&ies in 1995–2015. On the basis of behaviour of the discre"onary component of the na"onal #scal policy stances over the cycle they found a pro-cyclical bias, with only 20 to 45% of episodes of counter-cyclicali%, in the three sub-periods (pre-EMU, up to the crisis and the crisis) under considera"on. As regards the en"re euro area they considered the overall #scal impulse (the s&uctural and the discre"onary component of the #scal balance) and no"ced that, on aggregate, #scal policy was generally less pro-cyclical during the pre-crisis years than the analysis of individual counEKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 421 !ies suggested. "eir explana#on for this was that larger coun!ies (for instance Germany) were more counter-cyclical. Bénassy-Quéré et al. (2016, pp. 6–7), emphasise that since 2008 $scal policy in the Eurozone has not played its macroeconomic stabilisa#on role, except 2009 and 2011 when it was counter-cyclical. In 2008, 2012 and 2013 this policy was pro-cyclical (accentuated rather than a%enuated the cycle), and in the other years&— roughly neu!al. Pro-cyclicali' was mainly the result of the in(uence of the discre#onary part of $scal policy while automa#c stabilisers generally worked well. Data in chart 1 con$rm the results of the cited empirical studies. "e pro-cyclical discre#onary component of $scal policy (re(ected by posi#ve output gap and nega#ve changes in the s!uctural primary balance and vice versa) was s!ongly visible in 2000–2001 and 2012–2013. However, this !end was o)set by the cyclical component (automa#c stabilisers). 5. Poten!al forms and elements of "scal union in the euro area An important condi#on for a well func#oning monetary union is the existence of a su*ciently large element of solidari' or risk-sharing. All federa#ons (which also represent currency zones) have signi$cant common budgets that alleviate the outcomes of nega#ve shocks hi+ng their certain states or regions. Data in table 2 illus!ate the signi$cance of general government expenditure at cen!al and lower levels in EA–19 coun!ies and in some federal states. A very di)eren#ated situa#on of the Eurozone coun!ies in terms of the size and s!ucture of public expenditure would undoubtedly hinder the complete uni$ca#on of $scal policy in the euro area. Although federal states spend 11–35% of their GDP through federal budgets (table 2) they $nance many common goods, and macroeconomic stabilisa#on is only one of their aims. Assuming that the main purpose of euro area $scal capaci ' (or its unique mandate) would be producing signi$cant stabilisa#on, even a small common budget or a rainy day fund could provide enough business cycle smoothing, especially if it is focused on large shocks. According to Furceri & Zdzienicka (2013), member coun!ies’ annual con!ibu#ons of the order of 1.5% to 2.5% of GNP would have been su*cient to provide a level of risk-sharing comparable to that found in Germany (80% versus 40% for the Eurozone currently). Similar es#mates were made by Wol) (2012) who propose a $scal capaci ' of up to 2% of euro area GDP. "e crucial problem to solve during designing an e)ec#ve $scal risk-sharing device for the euro area is not only its size but also ("irion, 2017, p. 17): deciding whether to equip it with the competence to borrow in $nancial markets when coun!ies are simultaneously faced with a shock; choosing the appropriate measure of the posi#on in the business cycle on which !ansfers and con!ibu- #ons are made (output gap or unemployment rate) and the way of redis!ibu#ng EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 422 funds to maximise the stabilisa!on e"ect; as well as avoiding moral hazard and permanent #ansfers. We can dis!nguish two approaches to the crea!on of a euro area $scal insurance mechanism against economic shocks. %e macroeconomic approach assumes providing insurance either against coun#y-speci$c shocks, against common euro area-wide shocks or both, on the basis of ex ante or ex post #iggers based on macroeconomic performance indicators capturing the (rela!ve) posi!on of a coun#y in the business cycle. Transfers are usually based on output gaps or unemployment rates and they are disbursed directly to governments experiencing the shock. It is le& open whether a cen#alised $scal risk-sharing should take the form of a genuine euro area budget with common revenue and expenditure, of a joint rainy day fund, or of unemployment insurance. %e microeconomic approach envisages establishing a genuine common unemployment insurance scheme with unemployment bene$ts provided directly 'om the cen#al level to individuals in coun#ies hit by economic shocks. Such mechanisms already exist in federal states, e.g. in the United States (Iara, 2016, p. 305; Bénassy-Quéré et al., 2016, p. 14; %irion, 2017, p. 17). Among dozens of proposals of a common $scal capaci( some seem to be par!cularly interes!ng. %e Tommaso Padoa-Schioppa Group (2012), proposes a rainy day fund with ex ante funding (annual con#ibu!ons of the order of 1.5–2.5% GDP) providing automa!c macroeconomic $scal insurance against coun#y-speci$c shocks based on the na!onal output gaps rela!ve to the Eurozone output gaps. According to the authors, such a mechanism could limit the pro-cyclicali( of the single monetary policy and accelerate synchronisa!on of economic cycles within EMU. However, if the euro-area ouput gap would be much lower than zero, coun#ies hit by recession would be forced to pay those that were more severely a"ected. To avoid this problem some scien!sts suggest using coun#y’s own cyclical posi!on, without its rela!visa!on to the euro area as a whole (see e.g. Furceri & Zdzienicka, (2013), Pisani-Ferry et al. (2013), Caudal et. al. (2013) and Carnot et al. (2015) propose solu!ons allowing for allevia !ng not only asymme#ic but also common euro area-wide shocks. Pisani- Ferry et al. (2013) propose an automa!c #ansfer scheme based on devia!ons 'om poten!al outputs (among three other alterna!ves including a fully federal euro area budget amoun!ng to 2% of euro area GDP). To avoid moral hazard #ansfers would be made to governments only if the output gap is larger than a certain threshold (i.e. 2%) and would cover 25% of the shock’s size. Similarly Carnot et al. (2015) consider a payment threshold of about 25% of coun#y-speci $c output gaps 'om the fund collec!ng annual con#ibu!ons of 0.8% of GDP 'om the Eurozone coun#ies while Furceri & Zdzienicka (2013), suggest providing #ansfers propor!onal to the size of the shock. %e French Minis#y of Finance is a supporter of a euro area budget (with borrowing capaci() consis !ng of cyclical revenues (including corporate income tax) and countercyclical expenditure (e.g. unemployment bene$ts) aiming at mi!ga!ng consequences of symme#ic and asymme#ic shocks. Economic cycle smoothing should be EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 423 gained both through automa!c stabilisers and discre!onary measures (Caudal et al., 2013). "e #nal stabilisa!on e$ects of the euro area capaci% will depend not only on the size but also the &igger and speed of providing funds as well as the way of their alloca!on by member coun&ies (which have an alterna!ve op- !on to use part of them to consolidate debts instead of increasing countercyclical spending). Due to the 'equent errors in es!ma!ng output gaps many analysts support the use of unemployment rate as an indicator (taking into account that it is a lagged measure) of the posi!on in business cycle and the &igger of granting funds 'om a common #scal capaci%. "erefore, an academic debate has been concen&a!ng on a European unemployment (re-)insurance mechanism that could work as an important automa!c stabiliser in smoothing income and consump!on levels. It can be designed as a system of re-insurance of exis!ng na!onal unemployment insurance schemes at the cen&al level with intergovernmental &ansfers linked to short-term unemployment rates (macroeconomic approach) or as a fully-(edged European unemployment bene#ts insurance scheme for the euro area ci!zens with common #nancing and provisions (microeconomic approach). In the #rst case &ansfers to governments can be either earmarked or non-earmarked for unemployment bene#t expenditure (Bontout & Lejeune, 2013). Unemployment re-insurance schemes are proposed among others by the group of German analysts (von Bogdany et. al., 2013), who suggest alloca!ng &ansfers linked to high short-term unemployment rates to growth-enhancing investments; by Gros (2014), who advocates #nancing unemployment bene#ts but on the condi!on of gran!ng funds only in the situa !on of ‘catas&ophic’, i.e. the largest economic shocks, which reduces the risk of moral hazard; and by Bénassy-Quéré et al. (2016) who emphasises that any common unemployment (re-)insurance scheme would require at least minimal harmoniza!on of labour markets. A genuine euro area-wide unemployment insurance scheme to individuals (which would partly or fully replace na!onal unemployment systems) is proposed by Pisani-Ferry et al. (2013), Dullien (2013) and Dolls et al. (2016). To minimize moral hazard Dolls et al. (2016, p. 220), point to the necessi% of co-#nancing unemployment bene#ts by na!onal systems and of compulsory adop!ng of the proposed sovereign insolvency procedure (including debt res&ucturing). Due to the high euro area sovereign indebtedness eurobonds and other ins &uments designed to overcome it occupy an important place among many proposals enhancing #scal risk-sharing between the Eurozone members. In 2011 the European Commission presented three op!ons of eurobonds (Geeroms et al., 2014, p. 345): (1) fully (edged eurobonds with maximal risk-sharing, i.e. joint and several liabili% (meaning that each member state is responsible for the repayment of the full value of eurobond issue); (2) pooling only a por!on of borrowings with joint and several guarantees; (3) covering only parts of na!onal indebtedness with several but not joint government guarantees (responsibili% of member states only for their share in the pooled debt). As the #rst two opEKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 424 !ons involve mutual bailing out of sovereign debts by member coun"ies (which is forbidden by the TFEU) they need a Trea# change. Geeroms et. al. (2011), suggest a system of eurobonds issued at the same rate but with the receipts lent to member states using di$eren!ated interest rates (as the average interest rate would be too high for the northern core coun"ies and too low for the weaker ones). To deal with the problem of moral hazard Delpla & Weizsäcker (2010), propose mutualisa!on of the %rst 60% of sovereign indebtedness to GDP which would bene%t &om joint and several liabili# of the euro area members (‘Blue Bonds’) and the remaining amount of na!onal debt (‘Red Bonds’) which would be issued at higher costs related to the solvency and the riskiness of the coun- "y. Other related proposals include the crea!on of: a European Debt Agency issuing joint and several debt (Geeroms et al., 2014; Tommaso Padoa-Schioppa Group, 2012) or issuing debt without joint guarantees (Brunnermeier et. al., 2011); a European Debt Redump!on Fund re%nancing the member states’ public debt over 60% of GDP by eurobonds (Geeroms et al., 2014) as well as of a European Monetary Fund'— par!ally pre%nanced by coun"ies that breach the Maas"icht %scal criteria (Gros & Mayer, 2010). (e in"oduc!on of a Single Resolu!on Mechanism (the second pillar of the banking union) with a common resolu!on fund pre%nanced by the banking indus"y (another example of a kind of budget for the euro area) is an important stabilising tool because major asymme"ic shocks are caused by problems in the %nancial sector (Gros, 2014). It should also help to limit future bank bailout costs for governments. However, comple!ng a banking union with a third pillar (European Deposit Insurance System) backed by a common %scal backstop as well as a further dena!onalisa!on of banking policies (including less and diversi%ed exposure to sovereign debt) are necessary in order to prevent the feedback loop between sovereign and banks (Demertzis & Wol$, 2016). Deepening of %scal integra!on comprises also some proposals aiming at s"engthening the scope of coordina!on, e$ec!veness and elas!ci# of na!onal %scal policies within the euro area: (1) by crea!ng a suprana!onal ins!tu!on with a %nance minister with veto power on member coun"ies’ budgets (Enderlein & Haas, 2015); (2) by empowering the planned independent European Fiscal Board with iden!fying excep!onal !mes during which coordina!on is needed on top of monetary policy; (3) by replacing the insu)cient *exibili# of the SPG with respect to the economic cycle by na!onal adjustment accounts that would shi+ selec!ve cyclical spending form ‘bad’ to ‘good’ !mes when calcula !ng budget de%cits which helps to limit self-defea!ng %scal adjustments imposed on crises coun"ies (Bénassy-Quéré et al., 2016). 6. Conclusion (e theory of %scal federalism indicates that macroeconomic stabilisa!on in the common currency zone can be more e$ec!vely achieved via cen"al budget than local ones. Similar conclusions can be drawn on the basis of the OCA theory EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 425 which underlines an important role of !scal "ansfers between monetary union’s coun"ies that do not form an op#mal currency area and do not have a su$- ciently large, deep and well-integrated capital market (i.e. private risk-sharing). %e consensus developed by various economics schools in the course of their evolu#on supports the concept of !scal sustainabili& which suggests that !scal policy should be primarily based on automa#c stabilisers with the s"uctural budget balance (re'ec#ng discre#onary policy) at the very low level, especially in #mes of prosperi&. %e euro area macroeconomic performance so far (the average annual s"uctural budget de!cit of 2.5% of poten#al GDP (IMF, 2017b), an increasing level of public indebtedness (om 70.6% to 91.5% of GDP, and in par#cular the prevailing pro-cyclicali& of !scal policy in 1999–2016) con!rms that the current !scal (amework (the Maas"icht criteria, the SGP, the six-pack and two-pack legisla#ons, the European Stabili& Mechanism and the Fiscal Compact) has failed and be)er solu#ons, based on some form of !scal risk-sharing at the cen- "al level, should be sought. Among various proposals of ins"uments, which may become components of a !scal union in the euro area, the following are men#oned most o*en: a federal budget with own taxes and expenditure (possibly combined with borrowing capaci&); a European unemployment (re-)insurance scheme with be)er harmoniza#on of labour markets; other !scal (shock absorbing) insurance mechanisms of "ansfers between coun"ies (including rainy day funds); a larger EU budget and European taxes; harmoniza#on of taxa#on; joint guarantee for government debt; supplemen#ng the banking union with a common deposit insurance and/or a !scal backstop; insolvency procedure for sovereigns; !scal rules, policy coordina#on and supervision; a crisis resolu#on mechanism (extending the remit of the European Stabili& Mechanism); making na#onal !scal policies more stabilising by allowing incremental investment and unemployment expenditure to be shi*ed (om bad to good #mes based on na#onal adjustment accounts; the crea#on of an advisory European Fiscal Board, composed of independent experts, tasked with providing recommenda#on to the EC on the Eurozone !scal stance; the crea#on of ins#tu#ons with !scal authori& on a suprana#onal level (the euro area !nance minister). A !scal union may, but does not have to, include all of them. As emphasised by De Grauwe (2016, p. 155) there is no future for the euro without a minimum of solidari& and ‘the Eurozone can only be sustained if it is embedded in a !scal and poli#cal union’. Such a !scal union should involve: (1) a (par#al) consolida#on of na#onal government indebtedness, i.e. a common !scal authori& which can issue debt under the con"ol of that authori&, and (2) a (par#al) cen"alisa#on of na#onal government budgets into one cen"al budget, i.e. a mechanism of automa#c !scal "ansfers. At present full !scal uni!ca#on (cen"alisa#on of na#onal budgets and conduc #ng !scal policy at the euro area level) and a poli#cal union seem impossible both for economic reasons (large di+erences between member coun"ies EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 426 in terms of GDP per capita, the size of public expenditures in rela!on to GDP and their s"ucture, unemployment bene#ts and taxa!on systems, etc.) as well as poli!cal ones (the unwillingness of many states to completely renounce na- !onal sovereign$). %ere is also a great reluctance of some coun"ies (e.g. Germany and the Netherlands) to mutualisa!on of na!onal debt, and their a&tude towards this issue is unlikely to change in the near future. However, recent events (long-term economic stagna!on a'er the 2008/9 crisis, the Brexit decision in 2016 and the win of pro-European poli!cians in the Netherlands and France elec!ons) have led to a poli!cal will in most of the Eurozone coun"ies to launch a substan!ve discussion on a common #scal capaci$ dedicated just for the euro area. 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Von Bogdany, A., Calliess, C., Enderlein, H., Fratzscher, M., Fuest, C., Mayer, F.C., Schwarzer, D., Steinbeis, M.,Stelzenmüller, C., von Weizsäcker, J., & Wol$, G. (2013). Au(ruch in die Euro-Union. Die Zeit, 17 October. Wol$, G. (2012). A budget for Europe’s monetary union. Bruegel Policy Con$ibu !on, 2012(22). Acknowledgements Author con!ibu'ons: author has given an approval to the !nal version of the ar"cle. Funding: this research was fully funded by the Maria Curie-Skłodowska Universi$, Facul$ of Economics statutory sources. Note: the results of this study were presented at 9th In!rna"onal Conference on Applied Economics Con!mporary issues in Economy (June 22–23, Torun, Poland). EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 430 Appendix Table 1. General government net lending (+) or net borrowing (−) and consolidated gross debt (as % of GDP) in EU–19 and its member coun"ies in 1999–2016 Coun!y General government balance General government consolidated gross debt Government bond yield 1999 2016 1999–2016 spreads against Germany** average No of years with de"cit > 3% 1999 2016 1999–2016 average Change 2016/1999 Share of debt* EA–19 −1.5 −1.7 −2.7 5 70.6 91.5 77.3 20.9 100.0 − Belgium -0.6 −2.9 −1.9 5 114.4 106.8 101.6 −7.6 4.6 0.4 Germany −1.7 0.6 −1.6 7 60.0 68.2 68.2 8.3 21.8 − Estonia −3.3 0.1 0.3 1 6.5 9.9 6.7 3.4 0.0 n.a. Ireland 2.4 −0.9 −4.0 7 46.6 75.1 59.8 28.5 2.0 0.7 Greece −5.8 −1.1 −7.7 17 98.9 179.7 131.2 80.8 3.2 8.6 Spain −1.3 −4.7 −3.7 9 60.9 99.7 63.1 38.8 11.3 1.4 France −1.6 −3.3 −3.6 13 60.2 96.4 74.8 36.2 21.8 0.4 Italy −1.8 −2.3 −3.1 9 109.7 132.8 112.4 23.1 22.6 1.3 Cyprus −4.0 0.0 −3.2 10 54.8 107.4 69.5 52.6 0.2 3.8 Latvia −3.7 0.0 −2.5 5 12.1 39.4 25.1 27.3 0.1 0.5 Lithuania −2.8 −0.5 −2.8 7 22.7 40.8 27.8 18.1 0.2 1.0 Luxembourg 3.5 1.6 1.7 0 6.8 21.0 13.6 14.2 0.1 0.2 Malta −6.7 −0.7 −3.8 10 62.1 59.6 65.5 −2.5 0.1 0.9 Netherlands 0.3 −0.1 −1.7 4 58.2 62.2 55.7 4.0 4.4 0.2 Aus!ia −2.6 −1.4 −2.4 3 66.4 83.5 73.6 17.1 3.0 0.3 Portugal −3.0 −2.3 −5.3 15 51.0 130.5 85.8 79.5 2.4 2.9 Slovenia −3.0 −2.0 −3.8 8 23.7 80.9 41.3 57.2 0.3 1.2 Slovakia −7.3 −2.2 −4.7 9 47.1 52.1 43.2 5.1 0.4 0.4 Finland 1.7 −2.2 1.1 1 44.1 63.7 46.3 19.7 1.4 0.3 EA–19 SD 2.9 1.5 2.2 4.6 31.1 41.5 32.4 25.6 7.9 2.1 no of coun!ies with average de"cit > 3% in 1999–2016 10 total no of in$ingements by coun!ies with annual de"cit >3% in 1999–2016 145 Note: * In total EA debt in 2016 in %. ** Average of spreads $om January to August 2016. A%er European Commission (2016, p. 163). Source: Own prepara!on based on Ameco (2017) and Eurostat (2017) data as well as own calcula!ons. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 431 Table 2. General government revenue and expenditure (% of GDP) and expenditure breakdown (in % of GDP and in % of total government expenditure) in EA–19 and its member coun!ies, and in selected federa"ons in 1999–2015/6 Coun!y Total revenue in % of GDP Total expenditure in % of GDP Expenditure in % of GDP Expenditure in % of total government expenditure Cen!al (State) Local Social securi" funds Cen!al (State) Local Social securi" funds 1999–2016 1999–2016 1999–2015 1999–2015 1999–2015 1999–2015 1999–2015 1999–2015 EA–19 45.1 47.8 22.8 (6.1) 9.9 18.6 47.7 (12.8) 20.8 38.9 Belgium 49.8 51.8 29.0 (15.0) 7.0 19.5 56.1 (29.0) 13.5 37.6 Germany 44.0 45.5 13.8 (13.0) 7.5 19.8 30.3 (28.6) 16.4 43.5 Estonia 38.1 37.8 32.2 9.7 4.8 85.6 25.9 12.6 Ireland 33.6 37.6 35.5 7.9 − 92.8 22.2 − Greece 42.5 50.2 38.9 3.4 16.4 77.6 7.0 32.6 Spain 38.1 41.8 20.1 (15.0) 6.2 13.7 48.2 (35.9) 14.9 32.8 France 50.6 54.2 23.4 10.8 24.5 43.4 20.0 45.3 Italy 45.5 48.5 27.9 14.9 17.8 57.5 30.7 36.6 Cyprus 36.1 39.3 33.3 1.7 6.4 84.7 4.4 16.1 Latvia 34.8 37.2 21.6 10.2 9.1 58.0 27.3 24.2 Lithuania 34.3 37.1 26.1 9.1 12.5 70.1 24.5 33.6 Luxembourg 43.7 42.0 30.5 5.2 17.4 72.4 12.4 41.4 Malta 38.0 41.7 41.8 0.6 − 99.6 1.5 − Netherlands 43.0 44.7 26.4 14.9 16.1 59.0 33.4 36.0 Aus!ia 49.2 51.6 34.9 (9.1) 8.3 16.4 67.5 (17.7) 16.1 31.7 Portugal 41.6 46.8 35.2 6.5 11.3 75.2 13.9 24.0 Slovenia 43.4 47.3 30.5 8.9 18.1 64.3 18.9 38.3 Slovakia 37.4 42.1 28.0 5.9 14.0 66.2 14.3 33.2 Finland 53.4 52.3 26.5 20.4 16.9 51.3 39.4 32.6 EA–19 SD 6.1 6.3 6.8 4.7 5.0 17.4 (7.5) 9.8 8.9 Aus!alia 34.1* 35.8* 26.7* (14.2*) 2.1* − 74.5* (39.5*) 5.8* − Canada 39.2* 40.3* 14.0* (22.2*) 8.0* 2.9* 35.9* (55.7*) 20.0* 7.2* Switzerland 33.3 33.6 11.1 (13.2) 7.2 9.3 33.0 (39.2) 21.3 27.7 United States 32.4 37.8 13.5* (16.1*) − 9.4* 37.9* (45.1*) − 26.2* Note: *Data for the year 2015. Source: Own prepara!on based on Ameco (2017), Eurostat (2017) and IMF (2017a) data as well as own calcula!ons. EKONOMIA I PRAWO. ECONOMICS AND LAW, 16(4): 413–432 432 Chart 1. Changes y-o-y in the general government s!uctural primary balance (pp of GDP) and in the cyclical component (pp of GDP), and output gap (% of poten"al GDP) in EA–19 in 1999–2017 -4 -2 0 2 4 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 change y-o-y in s!uctural primary balance (pp of GDP) change y-o-y in cyclical component (pp of GDP) output gap (% of poten"al GDP) Source: Own prepara!on based on Ameco (2017) and IMF (2017b) data as well as own es!mates. Copyright of Ekonomia i Prawo is the property of Nicolaus Copernicus University in Torun and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.