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I'm still unclear why banking union inherently implies or leads to fiscal union. If individual govt's surrender their regulatory power of their banks, shouldn't, they still be able to set their budget and tax policy? When the govt issues bonds they would still be sold on the open market, but as long as they cannot force any bank to buy, I do not see an unsustainable moral hazard.
Perhaps surrendering even this bank oversight is too much for some govts, but it seems like a far easier sell than surrendering budgetary powers.
Imagine that Germany is guaranteeing the banks of Greece. The Greek government could nationalize a bank, or force Greek banks to buy Greek government debt, in either case extending the guarantee, meaning that the German government would be guaranteeing the Greek budget. Which would put us in some kind of fiscal union...
Justin, that's a good point. It is hard to imagine countries willing to give up sovereignty by being unable to nationalize a bank or force the bank to buy their debt. But let's suppose Greece were willing to do so. Even if the Greek government gave up the power to force banks to buy Greek debt, there are still a lot of ways the Greek government could subtly encourage the banks to buy its debt, rewarding or punishing people at the banks who did or didn't cooperate with political favors. It seems like it would be very hard for Germany to monitor that.
Also, fiscal policy can create national asset-price bubbles, which can then lead to banking crises within a particular country. With a banking union, all the countries would bear the burden of one country's fiscal-policy-induced banking crisis. That would generate moral hazard, so countries like Germany wouldn't be willing to form a banking union with less fiscally responsible countries in the absence of a fiscal union.
The key problem for a fiscal and banking union is that budget power is usually the key power of democratically elected parliaments in sovereign nation states, guaranteed by the constitution. Losing the control over national budget equals almost a loss of national sovereignty which for most EU countries like Germany would be also against the constitution, so constitutional control courts would ultimately stop any steps toward this direction. As you say, even if there weren´t legal constraints and a banking and fiscal union is implemented, there has to be some institution to operate and control this unions which would take years to build up and legitimize democratically.
Although, different countries are willing to take integration steps at different speeds, so sometimes politicians are talking about the "Europe of two speeds". A political dilemma is if some nations should be able to move on taking further integration steps (as the €) or if its more valuable if all EU countries move forward together on a slower speed.
The underlying problem of the EU are different visions in its member states governments of the EU being a supranational union as a type of multi-national confederation or rather something like a federal state. These different visions require compromises and lead to sometimes problematic decision outcomes, but there seems no other way to go. Sometimes you have to build the car while diving it.
Whether it is possible in the long run to create a fiscal union in view of the tightening of prudential regulation?
I am not so sure about the idea that a banking union would pool risk more efficiently. What about systemic risk? Let's imagine that the centralized banking regulator is not so good as we all think it is. Let's imagine that there is some flaw in the regulation designed in Brussels that, over time, creates a financial bomb that affects not just the banks of one or two countries but all the banks of the Union. The consequences could be even worse. Risk is frequency time consequences. Maybe by pooling regular risk we are able to lower the frequency and consequences of small banking crises but maybe we are creating the bases for potentially catastrophic failures albeit at a lower frequency.