Federalizing the Eurozone: The Fiscal Federalism Criteria in Optimum Currency Areas

As the European sovereign debt crisis has demonstrated, using fiscal stimulus, such as the European Economic Recovery Plan of 2008, to ignite economic recovery in an Economic and Monetary Union built without a full fiscal union, deprived of a lender of last resort and lacking the structure to activate an anti-crisis mechanism resulted in systemic banking stress, intense market pressure and the rise of government bonds to unsustainable levels in the peripheral Eurozone member states forcing several requests for international financial assistance. Nonetheless the monetary interventions of the European Central Bank, firstly as a reaction to the 2007/08 global financial crisis and the subsequently freeze in interbank lending and most recently with the initiation of its Quantitative Easing program, are equipping, it seems, the ECB with the appropriate monetary instruments to act as a de facto lender of last resort. In addition, institutional innovations such as the Fiscal Compact are fundamentally transforming the governance of EMU. As Clift and Ryner (2012: 152) argue, ‘in avoiding the nominal 3 per cent deficit target and deploying a structural balance target, [the Fiscal Compact] marks the evolution from Maastricht in terms of understanding the fiscal policy/growth Relationship’ Indeed, there is an ‘intelligent and flexible reading of the fiscal pact’ (Antonio Costa cited in Wise 2015) to be made that ‘tempers anti-Keynesian bias at the heart of the SGP [for the] utilisation of a structural balance framework carves out a role for counter-cyclical fiscal policy’ (Clift and Ryner 2012: 152). In other words, although the Fiscal Compact is normally defined in terms of tight fiscal discipline, in fact it can also be framed in terms of boosting domestic demand (Enderlein eand Spiess 2013: 4). This paper uses the, often forgotten, fiscal federalism criteria of Optimum Currency Area theory (De Grauwe 2013; Begg 2014) and asks whether these institutional reforms in the governance of the Eurozone are enhancing the long-term sustainability of the Eurozone? Short Reference List: o Begg, I (2014) ‘Genuine Economic and Monetary Union’, The New Palgrave Dictionary of Economics, Online Edition, 2014, pp, 1-16. o Clift, B. and Ryner, M. (2012) ‘Joined at the hip, but pulling apart? Franco-German relations, the Eurozone crisis and the politics of austerity’ French Politics 12: 2 p136–163. o De Grauwe, P. (2013a) ‘Design Failures in the Eurozone: Can they be fixed?’ London School of Economics “Europe in Question” Series LEQS Paer No. 57/2013. o Enderlein, H., Guttenberg, L., and Spiess, J. (2013) ‘Making one size fit all: designing a cyclical adjustment insurance fund for the Eurozone’, Notre Europe Policy P. 61, pp.1-16. o Wise, P. (2015) ’Portuguese left parties near pro-euro coalition deal’, Financial T, 13 Oct.