A French, German, and Canadian student were asked to write an essay on elephants......And the Canadian student titled his essay "Elephants: a Federal or Provincial responsibility?"
The Eurozone is what Canada would be if we abolished the Federal government, leaving only the Bank of Canada. The 16 Eurozone countries are the 10 Canadian provinces. Americans could draw a similar analogy.
What are the lessons for Canada from the Eurozone crisis?
1. A currency union with the US and Mexico? Forget it.
2. If Quebec separates, should it keep using the Canadian dollar? Forget it.
That's the easy bit.
3. Countercyclical fiscal policy should be as much as possible a Federal rather than a Provincial responsibility. I want to leave open the question of whether there should or should not be activist fiscal stabilisation policy; I just want to say that if there is, it should be done by the Federal and not the Provincial governments. The main point is that automatic fiscal stabilisers should be, as much as possible, Federal and not Provincial.
4. Provinces should keep the debts and deficits low. More importantly, Provinces should not issue too much short-term debt. Short-term debt must be rolled over. If the bond market fails, and it cannot be rolled over, it must be paid off. And that means running a budget surplus. It may be very difficult to increase tax revues or cut spending by a very large amount at very short notice. The maturities should be spread out so that there is never a large amount of debt due at any one time. In a liquidity and/or solvency crisis (the two feed off each other), the Federal Government can be supported by the Bank of Canada as lender of last resort, so this matters less than it does for the Provinces.
5. Banks, financial institutions and financial markets, or those which may create systemic risk or are at risk of a liquidity crisis, should be a Federal responsibility. Again, the Federal government has the Bank of Canada as lender of last resort. To minimise moral hazard problems, the same authority should be the regulator and the one that pays for any bailout if regulation fails.
6. Barriers to interprovincial mobility of labour, goods, and services should be minimised. Provinces in recession need to be able to export labour, goods, and services, to Provinces in boom.
7. We need to have clear and credible rules on exactly what would happen if a Province got into trouble. I propose that if a Province became insolvent, the Federal Government should take over that Province's fiscal policy, or else let the Province default. (The case of Newfoundland and Labrador in the 1930's is a sort of precedent, though the analogy is not exact.)
8. Creating a currency either creates a nation or creates a crisis.
9. Real institutions have to reflect, or evolve out of, real facts on the ground. They cannot be imposed from above by poncy elites. Otherwise, when the cliches hit the whatever, their rules will be worthless.
10. Something will always go wrong. A good system will be plastic enough and robust enough to deform rather than break when things do go wrong.