Europe’s Free Riders

In the United States, individual states that follow unsound fiscal policies face a penalty. Their bonds sell at a discount relative to those of better-managed individual states. The higher debt service they must pay serves – to some degree – as a form of discipline against the temptation to spend now and pay later.

Of course, the discipline of the market is not perfect: the bond market does not “see” implicit future liabilities (like promised pension payments) to any great degree. Nevertheless, this enforced fiscal discipline, combined with individual states’ own internal budgetary procedures, has prevented a large scale state-level fiscal crisis from occurring in the US since the Great Depression.