Abstract
New-style central banking in many advanced economies, involving the use of unconventional monetary policy instruments and forward guidance at the effective lower bound for interest rates, has raised questions about the appropriate role of fiscal policy – also in the euro area, where a fiscal counterpart to the European Central Bank (ECB) and the Eurosystem is missing. This paper considers three areas where euro area governments could act as the ‘joint sovereign’ behind the euro and support the ECB in its task of maintaining price stability, staying within the boundaries of the Maastricht Treaty. First, member countries could coordinate a growth-friendly aggregate economic policy mix that is supportive of the single monetary policy, with the help of a central fiscal capacity subject to common decision-making. Second, they could introduce a safe sovereign asset for the eurozone without assuming common liability in order to anchor financial integration and facilitate monetary policy implementation. Third, the significant benefits for the Eurosystem from a lower burden on monetary policy and a reduced exposure to sovereign risk could make it acceptable for euro area governments to indemnify it against potential large losses on its much expanded balance sheet. The fundamental solution, however, lies in advancing with fiscal integration to address the ‘institutional loneliness’ of the Eurosystem with full respect for its independent status.
Highlights
The Maastricht Treaty established the foundations of the Economic and Monetary Union (EMU) of Europe and laid down the legal framework for the introduction and functioning of the euro
The central banks of many advanced economies – including the European Central Bank (ECB) – employed forward guidance and unconventional instruments to provide a sufficient amount of monetary accommodation at a time when the equilibrium real interest rate was estimated to be very low and the conventional monetary policy rate hit the effective lower bound
Corsetti et al (2016a) fear that such a bias towards a too tight monetary policy, especially at the effective lower bound for short-term interest rates, would lead to an under-reaction to a financial crisis, more sluggish economic growth and too low inflation
Summary
The Maastricht Treaty established the foundations of the Economic and Monetary Union (EMU) of Europe and laid down the legal framework for the introduction and functioning of the euro. A euro area treasury to provide active fiscal support to the single monetary policy in reviving the euro area economy, assume final responsibility for the non-standard monetary policy operations and provide a fiscal backstop against large financial losses, is missing, reflecting the Eurosystem’s “institutional loneliness” at the EMU level (Padoa-Schioppa, 2000, p.37) This Maastricht Treaty set-up contrasts with the framework of other monetary unions where the central bank is embedded in a political union and has a clearly defined fiscal counterpart (Draghi, 2014; De Grauwe, 2016).
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