Fiscal Policy Externalities in the EMU: A Normative Assessment

The single European currency has been managed, much like the single market, by rules and technical regulations (i.e. the Stability and Growth Pact). The management of monetary policy was given to an independent central bank and fiscal policy is limited by rules. One of the justifications offered for the existence of these rules is the existence of externalities, for instance the ones created by the issuance of excessive public debt: Member States only partially internalize the cost of their public deficits, as the increase in interest rates is felt across the Eurozone, while the benefit are reaped by the national constituency. The existence of these spillover effects is inefficient and calls for though rules that constrain fiscally irresponsible states. The paper analyses first whether the concept of externality can justify this kind of reasoning and the supranational rules that constrain MS’s spending behaviour. It will be argued that the existence of externalities do not, by itself, justify supranational regulation. The justification of the rules does not come from economic analysis alone, but from an implicit moral defence of specific preferences. This poses a series of problems, since the institutional framework in which EMU fiscal policy is embedded, prevents the development of the kind of shared public reason necessary for such rules to be unanimously endorsed. The paper then proceeds to outline under which conditions and what kind of European powers should be exercised in the area of fiscal policy by recognizing how the (so far neglected) liberal values of legitimacy and that of justice can reinforce each other in producing acceptable outcomes. In specifying these conditions, special attention is given to the necessity of creating common political will, which is needed to appropriately justify the identification of those spillovers in fiscal policy that need to be internalized. Departing from the Bellamy and Castiglione’s (2013) analysis of the three models of European representation, it will be argued that national parliaments need to be at the centre of this process, if non-Pareto optimal decisions are to be considered just and legitimate.