In order to extract economic criteria for European fiscal federalism, Chapter 3 examines public accounts statistics and the economic literature on EMU from 1992 through the European sovereign debt crisis. It follows a chain of macroeconomic indicators running from nominal interest-rate convergence to the sovereign debt crisis. It examines nominal interest-rate convergence; structural determinants of sovereign bond yields; real interest rates; private-sector domestic credit; cross-border credit flows; consolidated banking claims; current-account imbalances; real effective exchange-rates; public and private-sector debt; the sovereign-bank feedback loop; and fiscal policy. The analysis finds that the Euro Crisis was a private debt crisis, not a public one. The causa sine qua non of the crisis is a severe mispricing of private and public debt caused by a failure of Articles 121-126 TFEU to induce markets to differentiate between sovereign borrowers under a (now realised) bailout expectation – not sovereign debt.

Chapter 8 seeks to extract principles of fiscal federalism for EMU and determine what models of fiscal federalism will ‘work’ in the context of the constitutional boundaries of the European legal order. Chapter 8 first extracts a number of institutional determinants of fiscal discipline in a decentralized federal system: market discipline; hard budget constraints; fiscal symmetry; expenditure and revenue autonomy; and specific characteristics for credibly-designed fiscal rules. It then tests those determinates in operation through a comparative analysis of five federations selected using a ‘most similar cases’ and a ‘prototypical cases’ methodology: Germany, Switzerland, the USA, Canada, and EMU. Chapter 8 finds that from the perspective of fiscal federalism theory, the incumbent prescriptions for centralised EU ‘fiscal union’ are - quite simply and profoundly - wrong. Centralised fiscal governance never works in a decentralised federation without market discipline, and contemporary economists already find the new governance framework no more credible than its predecessor.

Chapter 2 moves from the constitutional foundations of the European legal order to the architecture of fiscal federalism constructed atop them. It investigates where the constitutional principles identified in Chapter 1 inhere in the legal architecture of EMU, and explains the basic principles of economics inscribed for their attainment. The principles of fiscal sovereignty, price stability, and fiscal discipline are shown to penetrate three levels of investigation: The travaux préparatoires and the mandate for EMU (Article 119 TFEU); the allocation of competences in economic policy (Articles 2(3) and 5(1) TFEU); and the technical architecture governing public finance itself (Articles 121-126 TFEU). By those provisions, EU fiscal federalism rests on two principles: (1) Fiscal sovereignty – member state economic/fiscal competences remain outside the EU legal order altogether; and (2) market discipline –member states are exposed to ‘hard budget constraints’ and ‘market discipline’ to ensure fiscal discipline.

Chapter 4 concludes for Part I of the book by setting-out out two criteria for EU fiscal federalism which emerge from Chapters 1-3. First, any model of EU fiscal federalism must preserve the fiscal sovereignty the 28 (now 27) constituent constitutional democracies at the base of its legal order. Second, hard budget constraints and market discipline are indispensable requirements for price stability, sound public finances, and a sustainable balance of payments in an EMU bound by the fiscal sovereignty of its member states. Those criteria are tested and applied as the thesis of the book throughout Part II.

This chapter examines four flaws in the most essential assumptions underlying the single currency’s original stability set-up that were exposed by the crisis. The first concerns market discipline. The chapter looks at some of the key explanations for the failure of market discipline, in particular, those professed by the ECB. The second flaw concerns the instrument of public discipline. The shortcomings of this instrument were already visible in the early 2000s when France and Germany violated the Stability and Growth Pact. The chapter analyses these violations, the court case to which they gave rise and the reform of the Stability and Growth Pact that followed it in 2005. The third flaw concerns the excessive attention for budgetary discipline. In its preoccupation with ensuring fiscal prudence, the original set-up was blind to risks stemming from other corners of the economy, especially the banking sector. The fourth flaw is the cardinal one. Geared to safeguarding price stability, the single currency’s legal set-up left another stability dangerously exposed: financial stability. The chapter discusses its importance and the need to have it protected by a ‘lender of last resort’.