Mark Thoma. “EMF roundtable: Try a European Fiscal Fund.” Economist magazine roundtable. February 18th, 2010: “There are advantages to joining a currency union, but there are also costs. One important cost is that countries within the union cannot pursue individualised monetary policy.
For example, if Spain and Greece weren’t subject to the constraints that a common currency imposes, they could devalue their currencies to stimulate exports. Importantly, this could be used to offset the economic contraction that would be caused by bringing their deficits under control. But this is not possible under a common currency.
The fact that individual countries within the euro area cannot use monetary policy to stabilise their economies means they must rely upon fiscal policy as their main stabilisation tool. However, fiscal policy alone is not as effective at stabilisation as fiscal policy used in combination with monetary policy.
Fiscal federalism is one way to improve stability. Fiscal federalism is a broad topic, but here it is refers to resource transfers made by a centralised authority in an attempt to stabilise economic activity.
For example, when individual states within the U.S. have economic trouble, the federal government serves as an intermediary that transfers resources from states doing better in a relative sense to those doing relatively worse. These stabilising transfers happen automatically through federal tax collections (which are highest in states dong relatively well) and spending on federal social insurance programs (which is highest in states with the most problems).
Unfortunately, the European Union does not have an effective mechanism for transferring resources among countries in order to stabilise economic activity. The European Union’s taxation powers are very limited, and the resources that are collected are far short of what would be needed for effective economic stabilisation. Thus, enhanced fiscal federalism within the European Union could improve economic stability.”