How to design a euro fiscal union?

by Joerg Bibow

The fanfare that heralded the initiation of the euro has fallen flat: stagnant growth, elevated unemployment, wide divergence among member states, and rising inequality across the board, translate into the euro’s failure to deliver on its promises. The euro currency union bears a fundamental design flaw: it lacks viability without the creation of a corresponding fiscal union. What kind of fiscal union would serve to enhance the viability of the eurozone to forestall these system failures that are so evident?

For far too long, the debate in Europe was exclusively focused on the liability side of the public ledger: debt. But it is the asset side – whether or not investment is made in public infrastructure such as transport and energy, health, education and research – that is far more relevant in shaping our future. Europe’s leaders obsess in fears about the public debt that we are supposedly burdening our grandchildren with. Their foremost worry, however, should be about the investment that we are not undertaking. For the missing or spoiled public infrastructure will be the true burden we are bequeathing to our grandchildren.

Our fiscal priority should not be to balance the government budget or define maximum budget deficits for member states, but to require minimum levels for public investment spending. It is a great irony of Europe’s obsession with public debt that public debt levels have increased under the euro not because of excessive spending, but because of excessive and ill-guided austerity. Austerity – reckless cuts in government spending and tax hikes – has made us all the poorer. It is high time to focus our minds on what really matters: investment in Europe’s future.

Serious commitment to a viable public investment programme is at the center of the “Euro Treasury Plan”, a minimalist fiscal union that is necessary for sustaining the euro. The Euro Treasury Plan is minimalistic in focusing on public investment alone while leaving almost all fiscal responsibilities with the member states. At, say, 3 percent of GDP, the common budget would be quite small; much smaller than in the United States case, for instance.

The Euro Treasury proposed here is a common pool that funds public investment spending across the union by issuing common debt securities. The Euro Treasury would allocate investment grants to member states based on their GDP shares. It would collect taxes to service the interest on the common debt, also exactly in line with member states’ GDP shares. This design precludes a “transfer union” as benefits and contributions are shared proportionately. The joint public debt issued for investment purposes would not cancel out any existing national debts. The Euro Treasury securities would provide the means to fund the joint infrastructure spending which is the basis for the union’s collective future.

The Euro Treasury would function on the basis of a strict rule, the so-called golden rule of public finance, which foresees that public investment should be debt financed. Member states would still be required to abide by all the rules of the current euro regime, but this would apply to current public expenditures only – as national public capital expenditures would form a separate capital budget funded through common Euro Treasury securities. Once the key parameters are set for the Euro Treasury, there would be no discretion in fiscal decision making at the center. Public investment and the borrowing to fund it would simply grow at a steady pace year after year.

Although minimalist in design, the Euro Treasury Plan kills many birds with one stone. It safeguards and steadies the union’s public investment spending, which would also help stabilize economic activity and investment spending generally. The Euro Treasury provides the missing safe common debt securities that are of vital importance for the functioning of the common market and common currency. That private eurozone borrowers are still facing different interest rates based on their nationality contradicts the common market ideal of a level playing field and undermines the fundamental tenets of a common monetary policy. The term structure of risk-free interest rates on Euro Treasury securities would become the common benchmark for financial instruments issued by debtors of euro member-states, irrespective of nationality. The promise of the common market and common currency would finally be fulfilled.

Over time, a well-functioning Euro Treasury will enable member states to reduce their national public debts levels. This is crucial for restoring their fiscal space and capacity to respond to recessions. It is correct to view high national public debt as a source of fragility. The flaw in the current austerity dogma – that “stupid” pact – is to assume that blind austerity would take care of that risk. The correct approach is to concentrate the public debt, funding public investment, where it is safe: at the center of the union. This centralization is what we observe in other federal systems such as the United States. The common public debt is safe because the common Europe Treasury is partnered up with a common central bank: the ECB. Without a viable superstructure where the Euro Treasury works hand in hand with the ECB, the deleterious economic conditions that have befallen Europe will persist.

The lack of fiscal union is the ultimate flaw in the current euro regime and at the heart of the unresolved euro crisis. It is the norm that sovereign states have both a central bank and a treasury, in charge of monetary and fiscal policies, respectively. The euro has decoupled the monetary and fiscal authorities, a divorce that has left all parties concerned extremely vulnerable. Lacking a central bank partner, the national treasuries are subject to default and, hence, “runs”. When in panic mode, for whatever reason, financial markets can shut governments out from access to financial resources. A government might then even fail on its most basic responsibilities to its own citizens. Lacking a Euro Treasury partner with fiscal firepower, the ECB is vulnerable as well. The ECB’s monetary firepower alone has proved insufficient to restore growth following the crisis that struck the area a decade ago – even lowering its key policy interest rate into negative territory has failed to do the trick.

There is no reason to believe that monetary policy alone may be more powerful next time round. Fears are justified that the ECB may be largely out of ammunition at this point and will therefore be an even less viable counterforce when things turn down, again. The euro will lack a sure footing for as long as the ECB lacks a common treasury partner – establishing the vital treasury-central bank axis that stands at the center of power in sovereign states.

A few caveats are in order. The ETP does not present an optimal long-term euro fiscal union. It provides, however, a sound starting point focused on the euro’s most essential shortcoming. By making the euro viable, it will provide member states with the scope to better address other socio-economic failings and further advance the euro fiscal union.

The ETP alone will not secure the euro’s future. The minimalist fiscal union outlined here is a necessary, but not a sufficient condition for the euro’s survival. The other key condition is to prevent a repeat of those grave intra-area divergences and the corresponding buildup of imbalances as happened in the run-up to the euro crisis. To prevent a reoccurrence of such unsustainable trends, member states must not try to underbid each other, neither by wage repression nor other means. It is truly futile to abolish exchange rates with the aim of preventing competitive devaluations, then engaging in “beggar-thy-neighbor” policies through the backdoor. Member states should compete by nurturing productivity growth and a healthier natural and socio-economic environment – while making sure that everyone fully shares in the benefits.

The original euro experiment has failed. It is high time to relaunch the euro on a sounder footing. Working alongside a Euro Treasury would not only heal the euro’s potentially fatal birth defects but would also bolster growth immediately – by sponsoring a boost to public investment spending that is much needed. Austerity will not secure but, instead, destroy the euro’s future. Only public investment underwritten by a Euro Treasury can provide a sound basis for the union’s joint future. Public finance principles and experience tell us that such investment should be based on safe common debt – which is what the Euro Treasury Plan is all about.


Joerg Bibow is Professor and Chair of Economics at Skidmore College, New York, USA and Research Associate at the Levy Economics Institute of Bard College, Annandale-on-Hudson, New York, USA. His main research areas are international finance and European integration, as well as international trade and development and the history of economic thought. He holds a Diplom-Volkswirt degree from the University of Hamburg and MA and Ph.D. degrees in economics from the University of Cambridge.

His publications on the topic of a “Euro Fiscal Union” / a “Euro Treasury” include:

How to redesign the fiscal regime of the Eurozone? An alternative take on lessons from US and Eurozone experiences (ETUI Working Paper)

Making the euro viable: the Euro Treasury Plan, in European Journal of Economics and Economic Policies: Intervention, 2016 (1)

The Euro Treasure Plan, Public Policy Brief, Levy Economics Institute of Bard College

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