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Fiscal Policy and Monetary Union: Is There a Tradeoff between Federalism and Budgetary Restrictions?

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  • Barry Eichengreen
  • Jurgen von Hagen

Abstract

The Maastricht Treaty on Europe Union features an Excessive Deficit Procedure limiting the freedom to borrow of governments participating in the European monetary union. One justification is to prevent states from over- borrowing and demanding a bailout which could divert the European Central Bank from its pursuit of price stability. We challenge this rationale. Using data for a cross section of federal states, we find no association between monetary union and restraints on borrowing by subcentral governments. There is,however, an association between fiscal restraints and the share of the tax base under the control of sub-national authorities. Restraints are prevalent where subcentral governments finance a relatively small share of spending with their own taxes. Lacking control of the tax base, such governments cannot be expected to resort to increased taxation to deal with debt crises. Prohibiting borrowing by subcentral governments will not eliminate the demand for tax smoothing and public investment. Governments whose ability to provide such services is limited may therefore pressure the central government to borrow for them. We report evidence that the financial position of central governments is more fragile where subcentral jurisdictions are prevented from borrowing. The implications for the EU are direct. That EU member states control their own taxes should strengthen the hand of authorities seeking to resist pressure for a bailout. But in the longer run, borrowing restraints may weaken the financial position of Brussels, transferring bailout risk from the member states to the EU itself.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5517.

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Date of creation: Mar 1996
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Publication status: published as American Economic Review (May 1996).
Handle: RePEc:nbr:nberwo:5517

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  1. Buiter, W.H. & Corsetti, G. & Roubini, N., 1992. "Excessive Deficits: Sense and Nonsence in the Treaty of Maastricht," Papers, Yale - Economic Growth Center 674, Yale - Economic Growth Center.
  2. Alesina, Alberto F & Prati, Alessandro & Tabellini, Guido, 1989. "Public Confidence and Debt Management: A Model and a Case Study of Italy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 351, C.E.P.R. Discussion Papers.
  3. Jonathan Levin, 1991. "Measuring the Role of Subnational Governments," IMF Working Papers, International Monetary Fund 91/8, International Monetary Fund.
  4. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," Working Papers 73, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 647-61, September.
  6. Hughes Hallett, Andrew & Vines, David, 1991. "Adjustment Difficulties within a European Monetary Union: Can They be Reduced?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 517, C.E.P.R. Discussion Papers.
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Cited by:
  1. Juan Carlos Molero & Isabel Rodriguez-Tejedo, . "An index of political support for decentralization: the Spanish case," Faculty Working Papers, School of Economics and Business Administration, University of Navarra 05/08, School of Economics and Business Administration, University of Navarra.
  2. Miguel Braun & Mariano Tommasi, 2004. "Fiscal Rules for Subnational Governments. Some organizing principles and Latin American experiences," Public Economics, EconWPA 0410004, EconWPA.
  3. Solveen, Ralph, 1996. "Geldpolitik und Staatsverschuldung - welche Rolle spielt die Unabhängigkeit der Notenbank?," Kiel Working Papers 750, Kiel Institute for the World Economy.
  4. Veronica Grembi & Tommaso Nannicini & Ugo Troiano, 2011. "Policy Responses to Fiscal Restraints: A Difference-in-Discontinuities Design," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 397, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Thomas D. Willett, . "A Political Economy Analysis of the Maastricht and Stability Pact Fiscal Criteria," Claremont Colleges Working Papers, Claremont Colleges 1999-33, Claremont Colleges.
  6. Peter B. Kenen, 2000. "Currency Areas, Policy Domains, and the Institutionalization of Fixed Exchange Rates," CEP Discussion Papers, Centre for Economic Performance, LSE dp0467, Centre for Economic Performance, LSE.
  7. Ignazio Visco & Barry Eichengreen & Gilles Mourre & Declan Costello & Giuseppe Carone & Nuria Diez Guardia & Bartosz Przywara & Aino Salomäki & Vincenzo Galasso & Mark Weth & Sebastian Schich & Eti, 2007. "Money, Finance and Demography: The Consequences of Ageing," SUERF Colloquium Volumes, SUERF - The European Money and Finance Forum, SUERF - The European Money and Finance Forum, number 1 edited by Morten Balling & Ernest Gnan & Frank Lierman.
  8. Siebert, Horst, 1998. "Die Europäische Währungsunion: was zu tun und was zu lassen ist," Kiel Working Papers 854, Kiel Institute for the World Economy.
  9. Eduard Hochreiter & Anton Korinek & Pierre L. Siklos, 2002. "The Potential Consequences of Alternative Exchange Rate Regimes: A Study of Three Candidate Regions," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 76, Oesterreichische Nationalbank (Austrian Central Bank).
  10. Boyer, Robert, 2001. "The Economist Confronted by Epochal Innovations: The Relationships between History and theory," UCAIS Berkeley Roundtable on the International Economy, Working Paper Series, UCAIS Berkeley Roundtable on the International Economy, UC Berkeley qt4db8m5dg, UCAIS Berkeley Roundtable on the International Economy, UC Berkeley.
  11. Giuriato, Luisa & Gastaldi, Francesca, 2009. "The domestic stability pact in Italy: a rule for discipline?," MPRA Paper 15183, University Library of Munich, Germany.
  12. Boyer, Robert, 2001. "L'économiste face aux innovations qui font époque : les relations entre histoire et théorie," CEPREMAP Working Papers (Couverture Orange) 0112, CEPREMAP.
  13. Hochreiter, Eduard & Siklos, Pierre L., 2002. "Alternative exchange-rate regimes: The options for Latin America," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 13(3), pages 195-211, December.
  14. Vincent C. Blackburn & Richard Gerlach & Vasilis Sarafidis, 2007. "Dynamic Budgetary Adjustments in the Australian State Government Finance Sector: An Econometric Approach," Journal of Economics and Management, College of Business, Feng Chia University, Taiwan, College of Business, Feng Chia University, Taiwan, vol. 3(2), pages 125-159, July.
  15. Molero, Juan Carlos, 2003. "La Posición De Los Distintos Partidos Políticos Respecto A La Nueva Ley General De Estabilidad Presupuestaria: Su Influjo En Los Niveles Subcentrales De Gobierno
    [The Position Of Different Politi
    ," MPRA Paper 8072, University Library of Munich, Germany.
  16. Marco Catenaro, 2000. "Macroeconomic Policy Interactions in the EMU: A Case for Fiscal Policy Co-ordination," School of Economics Discussion Papers, School of Economics, University of Surrey 0003, School of Economics, University of Surrey.

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