In a new paper out this week, IMF researchers call for "deeper fiscal integration" among euro area countries. In reading the paper, it appears IMF researchers view the euro experiment as incomplete. Despite struggles during the global economic crisis and global recession, there is confidence in the euro area, but no so much in its current "architecture." From the paper: Large country-specific shocks. While it was recognized that countries joining the euro area had significant structural differences, the launch of the common currency was expected to create the conditions for further real convergence among member countries. The benefits of the single market were to be reinforced by growing trade, and financial, links—making economies more similar and subject to more common shocks over time (Frankel and Rose, 1998). In that context, these common shocks would be best addressed through a common monetary policy. Instead, country-specific shocks have remained frequent and substantial (Pisani-Ferry, 2012; and Figure 1). Some countries experienced a specific shock through a dramatic decline in their borrowing costs at the launch of the euro, which created the conditions for localized credit booms and busts. The impact of globalization was also felt differently across the euro area, reflecting diverse trade specialization patterns and competitiveness levels (Carvalho, forthcoming). These country-specific shocks have had lasting effects on activity. And divergences in growth rates across countries have remained as sizeable after the creation of the euro as before (Figure 2). Deeper into the paper we start to see some proposed solutions: Long-term options for the euro area. Cooperative approaches to foster fiscal discipline have shown their limits in the first decade of EMU. On that basis, and in light of international experience, two options emerge to foster fiscal discipline in the euro area in the longer term. One could be to aim to restore the credibility of the no bailout clause, including through clear rules for the involvement of private creditors when support facilities are activated. But the transition to such a regime would have to be carefully managed and implemented in a gradual and coordinated fashion, so as to not trigger sharp readjustments in investors’ portfolios and abrupt moves in bond prices. Another option would be to rely extensively on a center-based approach and less on market price signals. This would, however, have to come at the expense of a permanent loss of fiscal sovereignty for euro area members. In practice, the steady state regime might have to embed elements of both options, with market discipline complementing stronger governance. Read a summary of the paper, and download the full paper, here .
Filed under: monetary policy, recession, IMF, fiscal policy, debt, growth, recovery, EU, Christine Lagarde, financial crises, Europe, eurozone, Greece, Greece bailout, PIIGS, austerity measures, euro area, european banks, fiscal crises, growth shocks, fiscal resilience