Reconciling insurance with market discipline: A blueprint for a european fiscal union

Abstract

This contribution develops a blueprint for a European fiscal union. We argue that a viableEuropean fiscal union can be constructed without joint liability for public debt ora centralized government with a large common budget. Such a fiscal union shouldcombine elements of market discipline with stabilization in case of asymmetricshocks. Our proposal addresses the shortcomings of most other reform designs,which fail to offer a solution for insolvent or non-cooperative euro countries. We suggesta design which combines limited fiscal insurance with an orderly procedure to restructurethe debt of insolvent member states. We show that fiscal insurance and asovereign insolvency procedure are no contradiction but, on the contrary, are mutuallyreinforcing. Effective fiscal insurance helps to limit the stability risks involved inthe implementation of an insolvency regime for sovereigns. And vice versa, a welldefinedinsolvency procedure reduces the risk that a fiscal capacitymotivated as an insuranceagainst transitory asymmetric shocks degenerates into a permanent transfersystem. Moreover, we show that both elements promote the functioning of theEuropean banking union and the new European fiscal governance.