|
fiscal federalism
. The problem
with it is that the taxpayers of one country (here France) may not be happy in paying for government
spending and transfer payments in another country (in this example, Germany).
fiscal federalism
a fiscal system for a group of countries involving a common fiscal budget and a system of taxes and
fiscal transfers across countries
National Fiscal Policies in a Currency Union: The Free Rider Problem
Assuming that, for political reasons, fiscal federalism is not an option open to the currency union, we
still need to explore the possibility of individual members of the union using fiscal policy in order to
offset asymmetric macroeconomic shocks that cannot be dealt with by the common monetary policy. In
particular, in our example, what is wrong with Germany running a big government budget deficit in order to
counteract the fall in aggregate demand and borrowing heavily in order to finance the deficit? One answer
may lie in the effect on other members of the currency union of a rise in the debt of a member country.
Whenever a government raises its levels of debt to very high levels, there is always the possibility
that the government may default on the debt. In general, this can be done in one of two ways. Where
a country is not a member of a currency union and controls its own monetary policy, it can engineer a
surprise inflation by a sudden increase in the money supply, so that the real value of the debt shrinks. In
addition, when there is a sharp rise in the price level, this will usually be accompanied by a sharp fall in
the foreign currency value of the domestic currency. This means that, valued in foreign currency, the stock
of government debt will now be worth far less. Thus, the government has in effect defaulted on a large
portion of its debt by reducing its value both internally and externally.
If this is not possible – for example because, as in a currency union, the country no longer enjoys
monetary policy autonomy and is not able to devalue the external value of its currency (since it uses the
common currency) – then the only other way of reneging on the debt is through an outright default (e.g.
stopping interest payments or failing to honour capital repayments when they fall due). Generally, the
financial markets are good at disciplining governments that run up large debts, by charging them high
rates of interest on the debt that the government issues – after all, if you thought there was even a slight
possibility that you might not get your money back if you lent it, you would want to be paid a higher
rate of interest in order to compensate for that risk. Figure 36.5 shows the interest rate on ten-year
government debt in a selection of EU countries in March 2013 compared to March 2012. The overall cost
to governments of borrowing was lower in March 2013 reflecting the slightly more calm economic con-
ditions that prevailed at the time compared to a year previously. The differences in the cost of borrowing
is stark, however. The PIIG countries all face much higher interest rates on borrowing compared to the
stronger economies of Germany, France, the Netherlands, Sweden, Denmark, the UK and Switzerland.
The interest rate on Greek debt is extreme reflecting the parlous state of that country’s economy. It is
rarely impossible for a country to borrow money on international markets but if interest rates are higher
than about 7 per cent then the cost of servicing the debt becomes unsustainable in the longer term,
particularly if economic growth is weak as it has been in the PIIG countries. If the cost of borrowing is
consistently above 7 per cent then it is likely that governments will be in even more trouble and become
more likely to default.
774 PART 15 INTERNATIONAL MACROECONOMICS
In the case of a monetary union, therefore, this means that excessive debt issuance by one member
country will tend to force up interest rates throughout the whole of the common currency area. Although
the ECB controls very short-term interest rates in the euro area through its refinancing operations, it does
not control longer-term interest rates such as those paid on 10- or 20-year government bonds. Hence,
fiscal profligacy by a government in the euro area will tend to push up the cost of borrowing for all mem-
bers of the currency union.
However interest rates may not be raised enough to discipline properly the high-borrowing govern-
ment. This is because the markets feel that the other members of the monetary union would not allow the
country concerned actually to default, and that if it threatened to do so the other members would probably
rush in and buy up its government debt and ‘bail out’ the country concerned. If the markets believe in
this possibility then the debt will not be seen as risky as it otherwise would be and so the interest rates
charged to the debtor country on its debt will not be as high as they otherwise might be. The intervention
by the ECB, EU finance ministers and the International Monetary Fund (IMF) to bail out the economies
of Ireland, Greece and other countries since the financial crisis has been a case in point as ministers
struggled to keep EMU together.
The net effect is for that government to pay interest rates on its large stock of debt that are lower
because of the implicit belief that it will be bailed out if it has problems servicing the debt, and for all
other members of the currency union to pay higher interest rates on their government debt because the
government has flooded the financial markets with euro-denominated government bonds. In essence,
this is an example of the free rider problem: the government is enjoying the benefits of a fiscal expansion
without paying the full costs.
In addition, if that government is using the proceeds of its borrowing to fund a strong fiscal expansion,
this may undo or work against the anti-inflationary monetary policy of the ECB by stoking up aggregate
demand throughout the whole of the euro area.
In order to circumvent some of these problems, the currency union members can enter into a ‘no
bail-out’ agreement that states that member countries cannot expect other members to come to their
rescue if their debt levels become unsustainable, as an attempt to convince the markets to charge
Do'stlaringiz bilan baham: | 
