Economics, 3rd Edition

IN THE NEWS

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CHAPTER 36  COMMON CURRENCY AREAS AND EUROPEAN MONETARY UNION  779

some supplementary benefits for 

the  long-term unemployed. But this 

support is given to all states and 

thus does not provide those most 

affected with much more support 

than the others.

Moreover, unemployment bene-

fits are not as important as often 

assumed. In most countries they 

amount to only about between 

2  and  3 per  cent of GDP, even dur-

ing a major recession. In the US, the 

supplementary federal expenditure 

amounted to only about 1 per  cent 

of GDP in recent years. It is thus 

clear that a euro area unemploy-

ment insurance system would never 

be able to offset major shocks, such 

as the ones hitting Ireland or Greece 

where GDP has fallen by more than 

10 per cent.

All in all, it is difficult to rest the 

case for some euro area fiscal shock 

absorber on the US experience.

If business-cycle shocks were 

really the key problem, individual 

member states could first of all 

‘self-insure’ by running a prudent 

fiscal policy and lower their debt 

level so that they have the freedom 

to run temporary deficits in case 

they face temporary shocks. The 

‘Fiscal Compact’ with its target of 

approximate balance in cyclically 

adjusted terms is implicitly based on 

this idea.

Moreover, those member states 

that feel most exposed to business 

cycle shocks could very well agree 

among themselves to some mutual 

insurance scheme. There would be 

no need to make this scheme com-

pulsory for all member states if the 

aim is only to pool limited risks on an 

actuarially fair basis. It is of course 

true that the risk pooling becomes 

more efficient the more member 

countries participate (and the less 

their business cycles are correl-

ated). This implies that if a subgroup 

of member states starts such a sys-

tem (in the spirit of what is called in 

EU legal terms a ‘reinforced cooper-

ation’) the other member states 

should be attracted as well. The 

force of attraction of such a scheme 

would provide a litmus test of its 

usefulness.

Proponents of the idea that the 

euro area needs a fiscal shock- 

absorbing mechanism might thus do 

better proposing a concrete mech-

anism that could be implemented 

among a subgroup of member states 

instead of jumping to the conclusion 

that all member states be forced to 

pay a large part of their tax revenues 

into a euro area budget.