Thoughts on a Fiscal Union in EMU

Abstract

Using an estimated large-scale New-Keynesian model, we assess welfare and business cycle consequences of a fiscal union within EMU. We differentiate between three different scenarios: public revenue equalisation, tax harmonisation and a centralised fiscal authority. Relative to the status quo, long term consequences generate winners and losers depending on the degree of integration and on how key macroeconomic variables adjust. Short term differences between the regimes are minor, both in terms of business cycle statistics as well as in terms of risk sharing of asymmetric shocks. This also explains why welfare differences are negligibly small across the fiscal union scenarios. Even when introducing risk premia on government bonds, this general finding is not changed - although risk premia per se decrease welfare notably. We further perform a counterfactual exercise analysing the effects of what would have happened had a fiscal union regime been installed at the start of EMU already. While key macroeconomic variables would have reacted very similarly, debt dynamics could have changed notably over the estimation period.