P. Della Posta, R. Tamborini: The existential trilemma of the EMU in a fiscal target-zone model
The lesson we draw from the EMU crisis of the 2010s, and from the outbreak of the COVID-19 pandemic, is that the EMU, when exposed to large, systemic shocks, faces a trilemma among preserving its irreversibility, monetary orthodoxy and fiscal orthodoxy as established in the founding treaties: either monetary orthodoxy or fiscal orthodoxy, or both should be relaxed. First, we elaborate this concept by means of a fiscal target-zone model, in which EMU member governments are willing to abide by the commitment to debt stability under the no-bailout clause only up to an upper bound of their feasible fiscal effort. We show that EMU irreversibility, in order not to remain a wishful statement in the founding treaties, necessitates to be completed by carefully designed ramparts for extraordinary times along with regulations for ordinary times. Second, drawing on the target-zone literature, we show how these devices can be designed in a consistent manner that minimises their extension and mitigates the moral hazard concerns. The alternative to these devices is reformulating the treaties with explicit and regulated exit procedures.