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Fiscal Federalism: US History for Architects of Europe's Fiscal Union

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  • C. Randall Henning

    ()
    (Peterson Institute for International Economics)

  • Martin Kessler

    ()
    (Peterson Institute for International Economics)

Abstract

European debates over reform of the fiscal governance of the euro area frequently reference fiscal federalism in the United States. The "fiscal compact" agreed by the European Council during 2011 provided for the introduction of, among other things, constitutional rules or framework laws known as "debt brakes" in the member states of the euro area. In light of the compact and proposals for deeper fiscal union, we review US fiscal federalism from Alexander Hamilton to the present. We note that within the US system the states are "sovereign": The federal government does not mandate balanced budgets nor, since the 1840s, does it bail out states in fiscal trouble. States adopted balanced budget rules of varying strength during the nineteenth century and these rules limit debt accumulation. Before introducing debt brakes for euro area member states, however, Europeans should consider three important caveats. First, debt brakes are likely to be more durable and effective when "owned" locally rather than mandated centrally. Second, maintaining a capacity for countercyclical macroeconomic stabilization is essential. Balanced budget rules have been viable in the US states because the federal government has a broad set of fiscal powers, including countercyclical fiscal action. Finally, because debt brakes threaten to collide with bank rescues, the euro area should unify bank regulation and create a common fiscal pool for restructuring the banking system.

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Paper provided by Peterson Institute for International Economics in its series Working Paper Series with number WP12-1.

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Date of creation: Jan 2012
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Handle: RePEc:iie:wpaper:wp12-1

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Keywords: fiscal federalism; balanced budget rules; US financial history; state debt; euro crisis; fiscal compact;

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References

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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The European Debt Crisis in an American Fiscal Mirror
    by Manuel Bautista in NEP-HIS blog on 2012-02-05 09:37:05
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Cited by:
  1. Honkapohja, Seppo, 2013. "The euro crisis: a view from the North," Research Discussion Papers 12/2013, Bank of Finland.
  2. Győrffy, Dóra, 2014. "Válság és válságkezelés Görögországban. A puha költségvetési korlát szerepe a gazdasági összeomlásban
    [Crisis and crisis management in Greece. The role of soft budget constraints in
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(1), pages 27-52.
  3. Keuschnigg, Christian, 2012. "Welche Finanz- und Wirtschaftspolitik braucht Europa?," Economics Working Paper Series 1201, University of St. Gallen, School of Economics and Political Science.
  4. Antonio Estella, 2013. "Determinants of Spain’s decision to leave the European Monetary Union," EUI-RSCAS Working Papers 56, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
  5. Tröger, Tobias H., 2013. "The single supervisory mechanism - Panacea of quack banking regulation? Preliminary assessment of the evolving regime for the prudential supervision of banks with ECB involvement," SAFE Working Paper Series 27, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  6. Mario Sarcinelli, 2013. "The European Banking Union: Will It Be a True Union without Risk Sharing?," PSL Quarterly Review, Economia civile, vol. 66(265), pages 137-167.
  7. Keuschnigg, Christian, 2012. "Should Europe Become a Fiscal Union?," Economics Working Paper Series 1205, University of St. Gallen, School of Economics and Political Science.
  8. Angel Ubide, 2013. "Reengineering EMU for an Uncertain World," Policy Briefs PB13-4, Peterson Institute for International Economics.
  9. Antonio Estella, 2013. "Determinants of Spain's decision to leave the European Monetary Union," RSCAS Working Papers 2013/56, European University Institute.
  10. Winkler, Adalbert, 2013. "Der lender of last resort vor Gericht," Frankfurt School - Working Paper Series 206, Frankfurt School of Finance and Management.
  11. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.

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