An important question in the process of European integration concerns the best institutional level for fiscal stabilization policies. The theory of fiscal federalism provides criteria for evaluating if such stabilization policies should take place on a centralized or on a decentralized level. Instead of simply assuming that fiscal stabilization policies are a necessary part of a successful European economic and monetary integration, this paper first discusses the usefulness of such policies. It reaches the conclusion that fiscal stabilization policies are in general not an adequate way to respond to shocks. However, since fiscal stabilization policies appear to be unavoidable for political reasons, the paper then discusses on which institutional level such policies should be located. Decentralized fiscal stabilization policies are preferable because they are disciplined more by market forces, thus giving politicians less room for inefficient discretionary activities. In addition, supply side policies that make markets react more to shocks, and avoid a monetary union between countries that already have difficulty in coping with shocks, are important prerequisites for a successful European integration.
Working Paper Summaries 94/74: Fiscal Federalism in Europe: Is It a Necessary Precondition for a Successful European Economic and Monetary Integration?
- International Monetary Fund
- Published Date:
- August 1994