The world nowadays looks very much like the theoretical world that economists have traditionally used to examine the costs and benefits of monetary unions. The eurozone members’ loss of ability to devalue their exchange rates is a major cost. Governments’ efforts to promote wage cuts, or to engineer them by driving their countries into recession, cannot substitute for exchange-rate devaluation. Placing the entire burden of adjustment on deficit countries is a recipe for disaster.
In such a world, fiscal union is an essential counterpart to monetary union. If the gumbo industry goes into decline, driving the US state of Louisiana into a recession, residents will pay fewer federal taxes and receive more fiscal transfers. These financial flows are a natural counter-cyclical mechanism that helps local and regional economies to weather bad times. In a hypothetical European fiscal union, there would certainly be transfers from Germany to the periphery in 2011, but a properly designed setup would have ensured flows to Germany in the 1990’s, as it struggled to cope with the costs of reunification with East Germany.
With this in mind, the most obvious point about the recent summit is that the “fiscal stability union” that it proposed is nothing of the sort. Rather than creating an inter-regional insurance mechanism involving counter-cyclical transfers, the version on offer would constitutionalize pro-cyclical adjustment in recession-hit countries, with no countervailing measures to boost demand elsewhere in the eurozone. Describing this as a “fiscal union,” as some have done, constitutes a near-Orwellian abuse of language.