Sunday, March 27, 2016

Federations and debt

The article “Fiscal Federalism: US History for the Architects of Europe’s Fiscal Union” by C. Randall Henning and Martin Kessler is a fantastic source to draw lessons to make the European Project sustainable: “Before drawing too heavily on the US experience in concluding that constitutional debt brakes are a key solution to Europe’s debt problems, however, Europeans should consider three essential aspects of the context in which the balanced budget rules of the states operate. The US experience suggests that the particular path through which rules are adopted and enforced is likely to be critical to their implementation and that introducing such rules for euro area member states should be accompanied by a federal system of fiscal powers and a common fund for rescuing and recapitalizing banks. Consider these three caveats in turn. Within the US federal system, the states are “sovereign” with respect to debt.  (…) The second fundamental caveat is that the federal government’s relationship with the states must be seen within the context of a broader fiscal union. Since Alexander Hamilton’s plan was enacted, federal debt has been supported by the full system of federal powers, including a sweeping power to tax. The federal government’s role in public expenditure and taxation is large relative to the states. The theory of optimum currency areas has trained attention on the fiscal transfers among different regions of the country that are effected through the federal system of revenue and expenditures as well as through direct budget support to states and local governments. (…) US banking and capital markets are the third element of the context in which budget rules operate and the states relate to the federal government on fiscal matters. Compared with Europe, banks are less important conduits for finance relative to capital markets and bank regulation is less fragmented, being more of a federal responsibility. Stabilizing the banking system, along with stabilizing the macroeconomy, has been the responsibility of the federal government. In the United States, the states have not themselves undertaken large-scale bailouts or recapitalization of banks over the last century. As a consequence, the need to stabilize the banking system did not come into conflict with balanced budget rules at the state level. In the euro area, by contrast, harmonization of bank regulation is still young and the fiscal costs of bank rescues and recapitalization remain primarily a national responsibility. The introduction of debt brakes threatens to collide with the need to mount large-scale rescues of banking systems at the level of member states. As such provisions are put in place, therefore, it is all the more important that the euro area unifies banking regulation and creates a common pool of fiscal resources for rescuing, restructuring, and recapitalizing banks."

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