At its inception, it was thought that the euro area would at
most face moderate country-specific shocks, made rare by a common commitment to fiscal
soundness. In fact, not only have there been larger and more frequent idiosyncratic shocks but also
more idiosyncratic policies. For instance, many countries did not build sufficient fiscal buffers in
good times. Moreover, spillovers from idiosyncratic policies were not sufficiently taken into account.
Worse, the coupling of domestic fiscal and banking risks, together with extensive financial linkages
across countries, turned country-specific shocks into systemic ones, as there were no existing
mechanisms to deal with such shocks.
What are the minimal elements of a fiscal union that would make a future crisis less severe?
The ultimate scope and shape of the fiscal union will remain a matter of social and political
preferences. But to address the gaps identified above, four elements seem essential: (i) better
oversight and stronger incentives for sound national fiscal policies to build buffers and ensure
common concerns are addressed; (ii) subject to better oversight and stronger incentives, some
system of temporary transfers or joint provision of common public goods or services (e.g., organized
by a centralized budget) to increase fiscal risk sharing, (iii) credible pan-euro area backstops for the
banking sector to help break the sovereign-banking loop in the financial system, and (iv) some form
of common borrowing (backed by common revenue) to finance better risk sharing and stronger
backstops, and to reduce the potential for large portfolio shifts between sovereigns by providing a
safe asset.
most face moderate country-specific shocks, made rare by a common commitment to fiscal
soundness. In fact, not only have there been larger and more frequent idiosyncratic shocks but also
more idiosyncratic policies. For instance, many countries did not build sufficient fiscal buffers in
good times. Moreover, spillovers from idiosyncratic policies were not sufficiently taken into account.
Worse, the coupling of domestic fiscal and banking risks, together with extensive financial linkages
across countries, turned country-specific shocks into systemic ones, as there were no existing
mechanisms to deal with such shocks.
What are the minimal elements of a fiscal union that would make a future crisis less severe?
The ultimate scope and shape of the fiscal union will remain a matter of social and political
preferences. But to address the gaps identified above, four elements seem essential: (i) better
oversight and stronger incentives for sound national fiscal policies to build buffers and ensure
common concerns are addressed; (ii) subject to better oversight and stronger incentives, some
system of temporary transfers or joint provision of common public goods or services (e.g., organized
by a centralized budget) to increase fiscal risk sharing, (iii) credible pan-euro area backstops for the
banking sector to help break the sovereign-banking loop in the financial system, and (iv) some form
of common borrowing (backed by common revenue) to finance better risk sharing and stronger
backstops, and to reduce the potential for large portfolio shifts between sovereigns by providing a
safe asset.
