Keeping inflation down in a Currency Union: A Policy for Germany but not for many more...

In this post I describe how monetary union without fiscal union creates a fertile ground for permanent exposure to the damage of asymmetric shocks. One side of this equation is that the economy not affected by the negative shock still benefits from the low interest. This in turn leads to high rates of inflation. This should be a concern for any country, as the cheap credit may stimulate a bubble. For a country like Germany, there's the added cost of loss of competitiveness. It hit me a while ago that there's a simple solution to this problem: Germany can unilaterally tax loans. By doing this it should increase the cost of borrowing back up, and it shouldn't be particularly hard to figure out what the tax rate would have to be, given the decrease in the interest rate, to leave the after tax interest rate of Germany untouched, in order to abort the bubble before it grew.

The creation of the EFSF - such gripping drama

The FT has a fantastically well researched and sourced article on the events that led to the creation of the European Financial Stability Fund, "Dinner at the edge of the abyss", written by the great Tony Barber. Really good for anyone interested in the history of European integration and about what country stands for what in that debate.

European Fiscal Federalism (Part 3): Pigouvian taxation, and redistribution - Externalities, mobile assets, and euro interest rates

So far, I’ve been describing the economic logic for fiscal federalism. However I have not qualified it. It's all nice and easy to argue that we need to tax the richest and subsidise the poorest, but how do you do this? Which pockets should the EU reach into and what should it pay for?

In the next lines I propose the following Euro-level fiscal tools : (1)Taxes on mobile factors that cause negative externalities, (2)an Income tax, and the maintenance of a (3)common education policy as well as a (4)common defence policy, with a tendency for expansionary military R&D expenditure during recessions. Finally I also argue in favour of (5)the establishment of an European Monetary Fund (EMF) to switch from cooperation to coordination of euro-area fiscal policies. This would be the best tool to keep and improve the theoretically good monitoring devices created by the SGP, while replacing its very ineffective legalistic procedures, in order to improve fiscal stability across the board.

I believe these are the necessary tools for the EU to minimise its risks of suffering from asymmetric shocks, while endowing it with the policy tools to deal with them, should they arise, as they inevitably will. They may however not be sufficient...

European Fiscal Federalism (Part 2): OCA theory and the effects of asymmetric shocks

The first part of the comment described in the previous post belongs to a part of economics which is highly relevant for the Euro area, known as OCA (Optimum Currency Areas), their characteristics and their behaviour when faced with internally asymmetric (-like) economic shocks. Charles Wyplosz and Richard Baldwin have an extremely good book on the economics of the EU, which discusses this at length. DeGrauwe's book has a somewhat more superficial dicussion of a similar scenario, focused on the interest rate, while von Hagen and Mundschenk elaborate more thoroughly on a scenario closer to DeGrauwe's. Finally, Beetsma, Debrun and Klassen also provide some insights. The scenario discussed below is inspired by Baldwin and Wyplosz' but I've added some details.