1 THE FUTURE OF THE EURO AT 15: ROUNDING THE CORNERS OF THE HOLY TRINITY?

This paper takes a look at the future of the euro at 15 as a currency without a unitary state. Responding to the euro crisis, European leaders have put in place an enhanced governance framework and taken steps towards a banking union for the eurozone. This should secure sound national economic and fiscal policies, a healthy banking sector and the availability of a euro area fiscal backstop for member countries in distress. However, they stopped short of a further transfer of national sovereignty to the eurozone level. National governments therefore still have considerable leeway to ‘round the corners ’ of the eurozone’s ‘holy trinity ’ (one market, one money and one monetary policy), i.e. they may try to circumvent the hard budget constraint that should subject them to strong market discipline. Some appear to suppress market forces by targeting more captive sovereign debt markets. Such fiscal protectionism feeds moral hazard on the part of sovereigns, entrenches fragmented financial markets and frustrates the efficient allocation of capital in EMU which is vital for the proper functioning of the single monetary policy. The optimal solution to stabilise EMU and ensure its integrity may well be to establish a higher level of market-preserving fiscal federalism – involving a transfer of fiscal sovereignty to the eurozone level – which limits the ability of member countries to encroach on markets