ABSTRACT
Despite much advice to the contrary, EMU has started without the European Union having the means to undertake economic stabilization across the euro area. The purpose of this chapter is to question whether this is an important omission. To consider this, we reassess fiscal federalism and draw it together with the principle of subsidiarity. We argue that the traditional fiscal federalism paradigm, developed in the context of a single country, can lead to erroneous policy prescriptions if applied without qualification to the European Union. We agree with the observation that the ‘standard model of fiscal federalism is not appropriate for Europe. It relies on a functional specialisation at each level of government, emphasising the provision of local public goods while the main redistributive responses are undertaken by central government’ (Hughes and Smith, 1991: 452). We consider a range of theoretical and empirical issues, relevant shock symmetry or asymmetry and examine national stabilization efforts. We conclude that, on balance, there is no compelling evidence to force the European Union to introduce a stabilization scheme at the EU level. Moreover, there is considerable and growing evidence that, so long as flexibility in national fiscal policies is maintained, national budgets can provide sufficient stabilization. Through EMU, continued convergence can help reinforce this conclusion.
