European Monetary Union
North American lessons

The Maastricht Treaty on Economic and Monetary Union (EMU) provides for the establishment of a common currency area among European Union (EU) countries, but not a common fiscal policy. Some have argued that a community-wide tax and transfer system would be desirable in order to cushion asymmetric shocks, since member countries in a monetary union are not able to use the exchange rate instrument for that purpose. In Discussion Paper No. 1057, Research Associate Tamim Bayoumi and Paul Masson address this argument by investigating the role of US and Canadian federal flows in reducing both long-term regional income differentials (the redistributive function) and short-term regional business cycle fluctuations (the stabilization role). The former effects are investigated using cross-sectional regressions; the latter using time-series estimates. The authors then discuss the ability of EU countries to perform these roles.

In the United States, long-run flows amount to 22 cents in the dollar while the stabilization effect is 31 cents in the dollar. In Canada the redistributive effect is larger (39 cents) and the stabilization effect smaller (17 cents). Federal flows appear to depend on the institutional structure of the country concerned. In both countries, however, the redistributive element is considerably larger than the amounts involved in the EU Structural Funds programme. As for stabilization, national fiscal policies in the EU appear to have been as effective as federal governments in the United States and Canada in cushioning shocks to incomes. The authors conclude that it is a political choice as to how much redistribution should occur across countries, rather than an economic necessity related to monetary union. But political pressures for such redistribution may grow in the EU in response to other forces leading to increased integration, in particular the single market and EMU itself.

Fiscal Flows in the United States and Canada: Lessons for Monetary Union in Europe
Tamim A Bayoumi and Paul R Masson