Introduction

The European Monetary Union, as part of the European Union (EU), has been in a crisis since 2008. At that time, the economic and subsequent financial crisis (after 2009) revealed the precarious financial positions of Ireland, Portugal, Spain, Italy and above all, Greece. As a result, the possibility of financial default for these EU member states dominated European media for years. A primary reason for the problems suffered by these countries was often seen as the “windfall profits” from which they had benefitted due to favorable interest rates facilitated by currency union membership. These “windfall profits,” however, did not correspond to their competitive strength. The outcome was that these countries’ increases in government spending turned out to be unsustainable once macroeconomic conditions became less favorable. Consequently, imprudent fiscal behavior by some of its members put the European Monetary Union in a profound crisis. Any financial default would have led, so it was believed, to further speculation attacks on other member countries and, finally, to a break-up of the whole currency zone. The fiscal rules that had applied to the Eurozone since its introduction in 1998 (known as the “Stability and Growth Pact”) have not been able to prevent this situation. Only intense negotiations between member countries as well as the willingness of other countries to bail out those in financial crisis-something that had been explicitly excluded in the set-up of the currency union-have led to temporary stabilization. However, while on the one hand, the difficult situations of some member states led to intense political struggles between net payers and net receivers of such bailouts, on the other hand, the crisis triggered the reform of existing arrangements. “Members of the currency union decided to establish future “loan funds” such as the “European Financial Stability Facility” and, in 2012, the “European Stability Mechanism.” Moreover, they agreed to tighten enforcement mechanisms. Discussions on the transformation of the currency union into a fiscal union have been ongoing. This recent example of a currency union in crisis has some interesting lessons. First, it is an example of how deficit-making in federal or confederal unions can destabilize the whole union, provoking serious tension and conflict between its members. Second, it shows how fiscal unions can stimulate opportunistic behavior in members, such as with over-borrowing (deficit-making). Third, it provides an example of how bailouts can become almost the only possible solution for

saving the union. Finally, this also shows how such financial threats can impose fundamental reforms on existing intergovernmental fiscal arrangements. These lessons demonstrate the topics in which we are interested with this book, namely, how deficit problems and other types of opportunistic behaviors from fiscal policy-making members of territorial unions-we will focus on federal countries-can affect the stability of federal relations. Furthermore, we seek to find out how opportunism in fiscal policy-making can be prevented or coped with. There are numerous examples of financial defaults in the history of federal states; for example, Argentina, Brazil, Australia, India and Canada have experienced similar conflicts and struggles in finding collective solutions as in the case of the Eurozone. No federation has broken up yet because of conflicts regarding the deficit-making behaviors of subnational governments, but in each case, one finds political struggle with the ways and means of coping with this challenge. Our study deals with a concrete policy problem (fiscal consolidation), but our general ambition is to understand the ways and means of making federations “sustainable” (Riker 1964), “robust” (Bednar 2009) and “self-enforcing” (Filippov, Ordeshook and Shvetsova 2004; Weingast 1995). In short, we want to understand how federal states have solved or are solving what we will call “the deficit problem” in order to maintain “federal peace.”