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Is this a realistic prospect or a pipe dream?

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Show 2 Answers (Answer provided by Tyler Cowen)
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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...

But if as part of the German agreement, the Greek govt gives up the powers to nationalize a bank or force the banks to buy Greek debt (if they do take those steps, Germany withdraws the guarantee), then it seems like the banking union could be preserved without sliding into a fiscal union.

But what then with previous Greek commitments?

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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.

It's very obvious. For less budget-responsible countries fiscal union not so needed that for more-responsible.

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