Fiscal Policy in Europe: A Helicopter View

Abstract

We discuss the main fiscal policy issues in the Eurozone. Our goal is pedagogical: we do not make any new proposal, but try to represent fairly the various sides of the debate. We focus on two issues that are at the core of the current debate. The first is that, right from the start, the government deficit and debt were the key objects of contention in the debate that led to the creation of the Eurozone - and they still are, although the reasons have changed. The second, obvious issue is that a currency union implies the loss of a country-specific instrument, a national monetary policy. This puts a higher burden on fiscal policy as a tool to counteract shocks., a burden that might be even heavier now that the European Central Bank has arguably reached the Zero Lower Bound. Two obvious solutions are mutual insurance between countries; and a centralized stabilization policy. Yet both have been remarkably difficult to come by. We argue that the main reason is fear of persistent, unidirectional transfers between countries, an issue that largely reflects a Northern vs. Southern Europe divide.