Strengthening fiscal discipline in the EMU in a market-led approach.

Abstract

The undergoing eurozone crisis highlighted the importance of an effective mechanism to strengthen the fiscal discipline in the EMU. After looking into three mainstream approaches, the author believes that the market-led approach, which applies the market automatic adjustment system to strengthen the fiscal discipline, is the most promising one. This article then focuses on finding out the feasibility of this market-led approach and what need to be done to improve it.

By doing a comparative study on the US and the EMU in three aspects, namely the level of fiscal autonomy of sub-central governments, the strength of the economy to stand a sovereign default, and the possibility of a political majority for the no-bailout coalition, the feasibility of the central government's high credibility of its no-bailout commitment in the EMU is proved, providing the vital precondition for an effective market automatic adjustment mechanism. Then other preconditions are also examined, concluding that an effective market mechanism strengthening the EMU fiscal discipline is feasible. After this, two financial cushions are recommended to improve the effectiveness of the market, which are the fixed and small amount fiscal transfers and a second loss insurance.