Arnaud Mares of Morgan Stanley has written a good piece on fiscal federalism in Europe. By "fiscal federalism" he means a true lender of the last resort ie a mechanism to ensure that solvent govts will never become illiquid. Who could do be such a lender? The ECB. Mathematically a government is solvent if its debt doesn’t exceed the net present value of all future primary surpluses. However, as an assessment of the size of future primary surpluses is subjective, so is the assessment of solvency. The only situation where a central bank or an independent institution can assess a government’s solvency with confidence is when there are binding and persistent constraints on the course of fiscal policy. The limits to ECB intervention are political: it has no control over the fiscal stance of member states. The constraints embedded in the Maastricht Treaty and the Stability and Growth Pact have proved neither binding nor permanent. Fiscal federalism would mean full and permanent control from the union of governments at the federal level over the fiscal stance of each member state plus a permanent mechanism to ensure that all governments which submit to this federal control are fully funded on fair and equal terms. What matters to ensure government solvency is not who gets taxed and where public spending is allocated but the size of the deficit and the trend in the debt level. Is it possible to ensure full federal control over members’ fiscal deficits? Real control will never be achieved by a backward looking penalty system eg ex-post sanctions. There must be ex-ante control by a judicial or a funding route. Under a judicial route, budgets could be submitted to the European Court of Justice for validation. If the budget were rejected, that government would not be allowed to borrow. Under a funding route, governments could borrow from a central pool of resources with joint and several guarantees from all member states under 2 conditions: 1. The amount borrowed in one year never exceeds an amount compliant with federal law (the sum of redemptions plus the budget deficit, or minus the surplus), implied by full adherence to their Stability Programme. 2. The liability so incurred is super senior to all govt expenditure including any outstanding debts, current expenditure & capital expenditure. Bonds should be issued jointly and severally by the union of governments.
Do you think this is feasible or do you think countries will bust out of the Euro?