Europe has responded to the crisis with strengthened budgetary and macroeconomic surveillance, the creation of the European Stability Mechanism, liquidity provisioning by resilient economies and the European Central Bank and a process towards a banking union. However, a monetary union requires some form of budget for fiscal stabilisation in case of shocks, and as a backstop to the banking union. This paper compares four quantitatively different schemes of fiscal stabilisation and proposes a new scheme based on GDP-indexed bonds. The options considered are - (i) A federal budget with unemployment and corporate taxes shifted to euro-area level; (ii) a support scheme based on deviations from potential output;(iii) an insurance scheme via which governments would issue bonds indexed to GDP, and (iv) a scheme in which access to jointly guaranteed borrowing is combined with gradual withdrawal of fiscal sovereignty. Our comparison is based on strong assumptions. We carry out a preliminary, limited simulation of how the debt-to-GDP ratio would have developed between 2008-14 under the four schemes for Greece, Ireland, Portugal, Spain and an ‘average’ country.The schemes have varying implications in each case for debt sustainability.

https://www.econstor.eu/bitstream/10419/72119/1/735319456.pdf

Options for a Euro-area fiscal capacity

We estimate the pricing of sovereign risk for fifty countries based on fiscal space (debt/tax; deficits/tax) and other economic fundamentals over 2005-10. We measure how accurately the model predicts sovereign credit default swap (CDS) spreads, focusing in particular on the five countries in the South-West Eurozone Periphery (SWEAP: Greece, Ireland, Italy, Portugal, and Spain). Dynamic panel estimates of the model suggest that fiscal space and other macroeconomic factors are statistically significant and economically important determinants of market-based sovereign risk. However, risk pricing of the SWEAP countries is not predicted accurately by the model either in-sample or out-of-sample: unpredicted high spreads are evident during global crisis period, especially in 2010 when the sovereign debt crisis swept over the periphery area. We “match” the periphery group with five middle income countries outside Europe that were closest in terms of fiscal space during the European fiscal crisis. SWEAP default risk is priced much higher than the “matched” countries in 2010, even allowing for differences in fundamentals. One interpretation is that these economies switched to a “pessimistic” self-fulfilling expectational equilibrium. An alternative interpretation, consistent with the selective default of Greece in early 2012, is that the market prices not on current but future fundamentals, expecting SWEAP fiscal space to deteriorate markedly and posing a high risk of debt restructuring. Adjustment challenges in the Eurozone may be perceived as economically and politically more difficult for SWEAP than the matched group of middle-income countries because of exchange rate and monetary constraints.

What is the risk of European sovereign debt default

The present study contains a further (second) update of the comprehensive overview of the evolution of European (EU) banking law under the influence of public international banking law. It is structured in two Parts.

Part One, titled “Public International Financial Law (Regulation)” contains four Sections: Section A
gives the definition, presents the various branches, and undertakes a brief overview of the historical
evolution, in three periods, of public international financial law. The following Section B discusses
the four levels of the making and enforcement of public international financial law (political decisionmaking – adoption of the rules – coordination – indirect enforcement of rules) and its sources, with emphasis on the ‘Compendium of Standards and Codes’ of the Financial Stability Board (FSB). Section C presents then the international fora adopting international financial standards and the Committee on the Global Financial System. The Basel Committee on Banking Supervision, which is the main forum setting standards pertaining to public international banking law, is discussed in more details in Section D. The new Appendix I briefly discusses the measures taken at global level in relation to financial stability amidst the current pandemic crisis.

Part Two, titled “European (EU) Banking Law (Regulation)” is more detailed and structured in six
Sections: Section A gives the definition and the branches of EU financial law and then undertakes a
brief overview of its historical evolution, in four periods. Appendix I discusses in more details the
procedure for the making of EU financial law after the recent (2007-2009) international financial
crisis. Section B presents the developments in EU financial law as a result of the ongoing fiscal crisis in the euro area, which leads to the presentation of the (European) Banking Union (BU), including the still pending issues in relation thereto. The following Sections C and D present, in turn and briefly, the two main pillars of the BU, namely the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). Section E contains an analysis of the Deposit Guarantee Schemes Directive (DGSD) of 2014 and Section F briefly presents the Emergency Liquidity Assistance (ELA) mechanism, which refers to last resort lending to viable credit institutions in the euro area by the national central banks – members of the Eurosystem. The financial stability measures taken at EU level amidst the current pandemic crisis are discussed in the new Appendix III.

The cut-off date for information included therein is 31 December 2020.

The Evolution of European (EU) Banking Law under the Influence of (Public) International Banking Law: A Comprehensive Overview (Third fully updated edition)

This paper investigates the contribution of private and public channels for consumption risk sharing in the EMU over the period 1999-2015. In particular, we explore the role of financial integration versus international financial assistance for private consumption smoothing in this set of countries. In addition, we present a time-varying test which allows estimating how risk sharing has evolved since the start of the EMU, and in particular during the recent crisis. Our results suggest that, whereas in the early years of the EMU only about 40% of country-specific output shocks were smoothed, in the aftermath of the euro zone’s sovereign debt crisis about 65% of these shocks were absorbed, therefore reducing consumption growth differentials across countries. This progressive improvement of the shock-absorption capacity is due to a higher financial integration, but also to the activation of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) channelling official loans to distressed euro zone economies. We also show that cross-border holdings of equities and debt seem to be more effective than cross-border bank loans in isolating households from country-specific shocks, therefore contributing to consumption smoothing.

/pdf/private-and-public-risk-sharing-in-the-euro-area-4l7oapbiko.pdf

Private and Public Risk Sharing in the Euro Area

After significant progress as an immediate result of the euro crisis, the drive to complete Europe’s Economic and Monetary Union (EMU) has decelerated. While there is a broad consensus in Europe that EMU needs further development, the exact nature and timing of the reform agenda remains controversial. This paper makes an analytical contribution to the ongoing discussion about the euro area’s institutional setup. An in-depth look at the remaining gaps in the euro’s architecture, and the trade-offs that repairing them would present, suggests the need for long-run progress along three mutually supportive tracks. The first is more fiscal risk sharing, which will help enhance the credibility of the sovereign “no-bailout” rule. The second is complementary financial sector reforms to delink sovereigns and banks. And the third is more effective rules to discourage moral hazard. Helpfully, this evolution would ensure that financial markets provide more incentives for fiscal discipline than they do now. Introducing more fiscal union comes with myriad legal, technical, operational, and political problems, however, raising questions well beyond the domain of economics. These difficulties notwithstanding, without decisive progress to foster fiscal risk sharing, EMU will continue to face existential risks.

https://www.imf.org/-/media/Files/Publications/DP/2018/45611-resdp-fiscal-union-in-euro-area-022118.ashx

Revisiting the Economic Case for Fiscal Union in the Euro Area

Based on a combination of quantitative analysis and a qualitative forward-looking approach, this paper assesses both the state of play and the future capacity of the EMU to respond and adapt to asymmetric shocks. The objective is to provide a basis upon which to gauge the potential value added of a European Unemployment Benefit Scheme (EUBS), against the background of the recent plans for the Banking Union, the Capital Markets Union and the reform of the fiscal governance framework. We find that the capacity of the system to deal with asymmetric shocks (and in principle reduce their occurrence) is likely to increase due to these changes; but it will remain limited in the medium term and certainly lower than in the US. We also argue that given the broad pro-cyclicality of fiscal policy, the idea that national policies alone can deal alone with asymmetric shocks is not realistic. Lastly, we maintain that an ex-ante fiscal insurance mechanism can provide some degree of income smoothing and is likely to catalyse market insurance. Fiscal and market insurance can reduce the role of credit and borrowing, which until now has been the main channel for shock absorption in the euro area but also the least effective in times of crisis. We conclude that, from a macroeconomic point of view, an EUBS is a useful tool to improve shock absorption capacity and is not mutually exclusive with market risk sharing.

Assessing the Euro Area's Shock-Absorption Capacity: Risk Sharing, Consumption Smoothing and Fiscal Policy

Proposals for different types of elements of a fiscal union have flourished in recent years, both from academic and policy circles. Since a fiscal union could take a constellation of various different forms, this paper first provides an analytical framework pinpointing the five key elements of a fiscal union. It takes stock of the existing features of economic and monetary union (EMU) that embed some form of fiscal union, and then critically analyses the main arguments for and against further fiscal integration. Finally, It surveys the key proposals for a fiscal capacity and different types of Eurobonds.

European Fiscal Union: Economic Rationale and Design Challenges

On May 31st, the European Commission issued a reflection paper on the deepening of the Economic and Monetary Union calling for a far-reaching debate on reforms to the economic governance architecture of the euro area. The Commission’s document also states that a fiscal stabilisation function for the euro area could be envisaged in the longer run (2020-25) in addition to the deepening of private risk-sharing mechanisms. The present paper offers a timely contribution to the important debate on the design of a possible fiscal stabilisation function for the euro area by assessing the stabilising effects and the nature of the US federal tax-transfer system to shocks. We question the mainstream argument for a euro area ‘fiscal capacity’, which revolves around the need to “dampen the effects of asymmetric shocks”, and argue that there are important lessons to be derived from US federal fiscal risk-sharing institutions, but that they are not what policymakers typically envisage.

Fiscal Risk Sharing and Resilience to Shocks: Lessons for the euro area from the US

This paper compares the capacity to smooth the impact of asymmetric shocks in the US and in the euro area (EA) and examines the various mechanisms through which the shock absorption occurs. It first notes that comparable data for the US and the EA are not readily available, and that in the US, state accounting is such that what the literature commonly calls international risk-sharing in reality embeds inter-temporal consumption-smoothing through retained corporate earnings. With this in mind, we build euro area aggregates suitable for comparison. Our findings confirm that international capital markets in the US are a more powerful tool for risk-sharing than in the EA, but less so than previously reported. The better performance of the US is explained by very poor shock-absorption dynamics in the peripheral euro area countries, especially after 2010, as well as by a higher persistence of shocks in the euro area relative to the US.

Risk-sharing and Consumption-smoothing Patterns in the US and the Euro Area: A comprehensive comparison

this paper assesses both the state of play and the future capacity of the EMU to respond and
adapt to asymmetric shocks. The objective is to provide a basis upon which to gauge the
potential value added of a European Unemployment Benefits Scheme (EUBS), against the
background of the recent plans for the Banking Union, the Capital Markets Union and the
reform of the fiscal governance framework. We find that the capacity of the system to deal
with asymmetric shocks (and in principle reduce their occurrence) is likely to increase due to
these changes, but it will remain limited in the medium term and certainly lower than in the
US. We also argue that given the broad pro-cyclicality of fiscal policy, the idea that national
policies alone can deal alone with asymmetric shocks is not realistic. Lastly, we maintain that
an ex-ante fiscal insurance mechanism can provide some degree of income smoothing and is
likely to catalyse market insurance. Fiscal and market insurance can reduce the role of credit
and borrowing, which until now has been the main channel for shock absorption in the euro
area but also the least effective in times of crisis. We conclude that, from a macroeconomic
point of view, an EUBS is a useful tool to improve shock absorption capacity and is not
mutually exclusive with market risk sharing.

Assessing the Euro Area’s Shock-Absorption Capacity Risk sharing, consumption smoothing and fiscal policy. CEPS Special Report No. 146 / September 2016

Gilles Thirion

Papers

Assessing the Euro Area's Shock-Absorption Capacity: Risk Sharing, Consumption Smoothing and Fiscal Policy

European Fiscal Union: Economic Rationale and Design Challenges

Fiscal Risk Sharing and Resilience to Shocks: Lessons for the euro area from the US

Risk-sharing and Consumption-smoothing Patterns in the US and the Euro Area: A comprehensive comparison

Assessing the Euro Area’s Shock-Absorption Capacity Risk sharing, consumption smoothing and fiscal policy. CEPS Special Report No. 146 / September 2016