How to herd cats : economic policy coordination in the Euro zone in tough times

This paper addresses the issue of fiscal policy coordination in the context of the current crisis. It first aims at clarifying the economic rationale for fiscal policy coordination in a monetary union with decentralized fiscal authorities, and at exploring the foundations of the kind of coordination devices chosen, as well as the incentives and constraints on member states' governments arising from the fiscal rules in the Euro Zone, both in tranquil and in stormy economic times. We then proceed with an analysis of the difficulties arising from the heterogeneous nature of the Euro Zone. In Section 3, we explore some of the possible causes of heterogeneity, with an emphasis on the issue of collective action and country size, with the coexistence of large and small countries, facing different incentives and constraints, hence tending to adopt divergent strategies in the occurrence of common macroeconomic shocks. Section 4 addresses the possible evolution in automatic fiscal stabilizers and Section 5 documents the size and structure of national fiscal stimulus packages. The concluding section advocates a better mix of rules and discretionary coordination for fiscal policies in the Euro Zone.