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Fiscal federalism: US history for architects of Europe's fiscal union

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  • C. Randall Henning
  • Martin Kessler

Abstract

Ever since first the blueprints for monetary union in Europe were drawn up, the United States, considered as a collection of individual states or regions, has served as a benchmark for assessing its feasibility and evaluating alternative policy options. Starting with Robert Mundell’s seminal 1961 article on optimal currency areas, countless papers have explored the inner workings of US labour, product and capital markets, and of its public finances, in the hope of learning lessons for Europe.It could be argued that this US inspiration is mistaken. After all, it is not the only economic and monetary federation in the world. Other federations work on different principles – especially when it comes to public finances – and there is no guarantee that US arrangements are optimal – especially, again, regarding public finances. But we know the US better and we think we understand it better, so success or failure relative to the US test carries much more weight than with the Australian, Canadian, Indian or Swiss tests. For better or worse, the US remains our ultimate policy laboratory.This essay on US fiscal federalism by Randall Henning and Martin Kessler builds on the established tradition. But unlike many papers that take current US features as a given, they tell us what present arrangements governing responsibility over public debt gradually emerged from, and why. By bringing in the historical dimension and the trial-and-error process that took place over more than two centuries, they help us understand the logic behind alternative arrangements and why the current one has in the end prevailed. Their careful historical account yields several important lessons. It first recalls that the US system as we know it, with its combination of a large federal budget responsible for the bulk of public debt and limited thrifty state budgets subject to balanced budget rules, emerged gradually from a sequence of events; in fact the initial set-up, as designed and enforced by Alexander Hamilton, was almost exactly the opposite.Second, it makes clear that beyond economic principles, attitudes towards what was in the aftermath of independence called the ‘assumption’ of state debt were shaped by broader political considerations – not least the aim of building a genuine federal government.Third, it explains how after the US was firmly established as a federation, changing political conditions led to a reversal of the federal government’s stance and to the enforcement of a ‘no bail-out’ principle.An intriguing feature of US history is therefore that the competences and features of federal government grew out of its assumption of state debt, and that the centre imposed a de-facto no bail-out regime only after having assumed essential powers.Another interesting observation by Henning and Kessler is that balanced budget rules were adopted spontaneously by states in response to financial stress and defaults, rather than as a disciplinary device mandated by the centre. Thus, there is still significant variability between states regarding the modus operandi and strictness of budget rules. The question remains if what matters is the strictness of the rule, or deeper political preferences at state level, of which the rule is only an expression.Finally, Henning and Kessler emphasise, a no less important lesson for Europe is that policy principles and institutions should be looked at as a system rather than in isolation. As the authors point out, it may seem obvious to recall that states in the US can abide by strict budget balance rules to the extent the federal government is responsible for stabilisation and the bail-out of insolvent banks, but this simple lesson is sometimes overlooked in European discussion.Jean Pisani-FerryDirector of Bruegel

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  • C. Randall Henning & Martin Kessler, 2012. "Fiscal federalism: US history for architects of Europe's fiscal union," Essays and Lectures 669, Bruegel.
  • Handle: RePEc:bre:esslec:669
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    References listed on IDEAS

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    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 15:37:05

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    Cited by:

    1. Cristina Arellano & Andrew Atkeson & Mark Wright, 2016. "External and Public Debt Crises," NBER Macroeconomics Annual, University of Chicago Press, vol. 30(1), pages 191-244.
    2. Tröger, Tobias, 2013. "The Single Supervisory Mechanism - Panacea or Quack Banking Regulation? Preliminary assessment of the evolving regime for the prudential supervision of banks with ECB involvement," IMFS Working Paper Series 73, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    3. Vladimir Mau, 2013. "Between modernisation and stagnation: Russian economic policy and global crisis," Post-Communist Economies, Taylor & Francis Journals, vol. 25(4), pages 448-464, December.
    4. Thirion, Gilles, 2017. "European Fiscal Union: Economic rationale and design challenges," CEPS Papers 12160, Centre for European Policy Studies.
    5. Fritz Breuss, 2012. "Towards a New EMU," WIFO Working Papers 447, WIFO.
    6. Tyrole, J., 2012. "The euro crisis: some reflexions on institutional reform," Financial Stability Review, Banque de France, issue 16, pages 225-242, April.
    7. repec:ksa:szemle:1732 is not listed on IDEAS
    8. Paul J. J. Welfens, 2016. "Overcoming the euro crisis and prospects for a political union," International Economics and Economic Policy, Springer, vol. 13(1), pages 59-103, January.
    9. Fahrholz Christian & Freytag Andreas, 2014. "Finanzpolitik in Europa zwischen Subsidiarität und Vergemeinschaftung: Eine ordnungsökonomische Analyse / Between subsidiarity and Europeanization: An ordo-liberal perspective on financial policy," ORDO. Jahrbuch für die Ordnung von Wirtschaft und Gesellschaft, De Gruyter, vol. 65(1), pages 99-116, January.
    10. Antonio Estella, 2013. "Determinants of Spain's decision to leave the European Monetary Union," RSCAS Working Papers 2013/56, European University Institute.
    11. 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.
    12. 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 the economic co
      ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(1), pages 27-52.
    13. Schelkle, Waltraud, 2017. "Hamilton’s Paradox Revisited: Alternative lessons from US history," CEPS Papers 12963, Centre for European Policy Studies.
    14. Armin Steinbach, 2015. "The Mutualization of Sovereign Debt: Comparing the American Past and the European Present," Journal of Common Market Studies, Wiley Blackwell, vol. 53(5), pages 1110-1125, September.
    15. Winkler, Adalbert, 2013. "Der lender of last resort vor Gericht," Frankfurt School - Working Paper Series 206, Frankfurt School of Finance and Management.
    16. Keuschnigg, Christian, 2012. "Welche Finanz- und Wirtschaftspolitik braucht Europa?," Economics Working Paper Series 1201, University of St. Gallen, School of Economics and Political Science.
    17. Honkapohja, Seppo, 2014. "The Euro Area Crisis: A View from the North," Journal of Macroeconomics, Elsevier, vol. 39(PB), pages 260-271.
    18. Christian Keuschnigg, 2012. "Should Europe Become a Fiscal Union?," CESifo Forum, Ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 13(1), pages 35-43, April.
    19. 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).
    20. Angel Ubide, 2013. "Reengineering EMU for an Uncertain World," Policy Briefs PB13-4, Peterson Institute for International Economics.
    21. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
    22. Virkola, Tuomo, 2014. "Fiscal Federalism in Four Federal Countries," ETLA Reports 38, The Research Institute of the Finnish Economy.

    More about this item

    JEL classification:

    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • N41 - Economic History - - Government, War, Law, International Relations, and Regulation - - - U.S.; Canada: Pre-1913
    • N42 - Economic History - - Government, War, Law, International Relations, and Regulation - - - U.S.; Canada: 1913-

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