A tighter Fiscal Compact would practically eliminate the risk of default.

Hence the rising risk of a major downturn and additional fiscal distress.

Undetected imbalances and systemic risk make fiscal policies seem prudent when they are not.

In fact, there is a strong risk that this legislation would ultimately add to the fiscal deficit.

Finally, in the face of political opposition to fiscal consolidation, especially in the US, there is a risk that the path of least resistance becomes continued monetization of fiscal deficits.

With the right balance of vision and caution, China s leaders can tackle the buildup of fiscal and financial risk.

With the right balance of vision and caution, China s leaders can tackle the buildup of fiscal and financial risk.

NEW YORK Today s swollen fiscal deficits and public debt are fueling concerns about sovereign risk in many advanced economies.

While the risk that governments will succumb to fiscal temptation remains, citizens current suffering is likely to deter future excesses.

But sounder fiscal policy might lead to even higher inflows as the country s external balance and sovereign risk outlook improve.

The European Commission s claim that this slowdown reflects high sovereign default risk, rather than fiscal consolidation, is belied by the UK, where the sovereign risk is deemed by markets to be virtually nonexistent.

To reduce the risk of financial pressures on Italy and Spain, both countries need to press ahead with fiscal austerity and structural reforms.

No risk factor is more dangerous for a currency than policymakers refusal to face fiscal realities until European officials do, the euro remains vulnerable.

But unresolved structural problems have meant that the stimulus packages generated significant fiscal and financial risk, while doing little to improve China s capital stock.

That is why risk premiums are continuing to fall in the eurozone, despite high political uncertainty in Italy and continuing large fiscal deficits elsewhere.

At this point, peripheral countries will regain their fiscal sovereignty and will be able to ignore Reinhart and Rogoff s warning at their own risk.

If the EU wants a monetary union in which sovereign debt is relatively homogenous with respect to risk, fiscal discipline must be similarly homogenous.

The dysfunctional system of European fiscal governance should be dismantled fiscal responsibility should be returned to member states and, to minimize the risk of excessive future lending, private lenders should be required to bear the losses implied by unsustainable sovereign debt.

The government (the visible hand) sets the benchmark price for risk free financial assets through monetary policy and control over fiscal deficits, while the market (the invisible hand) sets the risk premia of risky assets above the benchmark rate.

If they take away the monetary and fiscal stimulus too soon when private demand remains shaky there is a risk of falling back into recession and deflation.

The eurozone, currently wrestling with fiscal imbalance and sovereign debt risk, has a strong and autonomous central bank, but is fiscally fragmented and only partly unified politically.

The fifth option is to tighten fiscal policy and reduce budget deficits with the aim of lowering the high interest rates that drive the inflows. But sounder fiscal policy might lead to even higher inflows as the country s external balance and sovereign risk outlook improve.

The collective judgment of financial markets on any government s economic and fiscal policy is expressed in the risk premium that the government must pay on its external debt.

In some countries with high levels of debt and impaired growth, fiscal stimulus could raise the risk premium on sovereign debt and be counterproductive others have more flexibility.

Moreover, recession insurance might, in contrast to fiscal policy, impose no costs on the government, for if it stimulates confidence, then the risk being insured against is prevented.

Peter Kenen argued in the late 1960 s that without exchange rate movements as a shock absorber, a currency union requires fiscal transfers as a way to share risk.

The biggest policy risk is that the exit strategy from monetary and fiscal easing is somehow botched, because policymakers are damned if they do and damned if they don t.

When a local government is no longer able to service its debt, the central government will have to place its own fiscal capacity at risk by assuming the responsibility.

The unprecedented explosion of America s fiscal deficit raises the risk of high inflation in the future exactly the kind of scenario that Europeans want to prevent at all cost.

If America s Democrats lose in the mid term elections this November, there is a risk of persistent fiscal deficits as Republicans veto tax increases while Democrats veto spending cuts.

Not only is QE s ability to jumpstart crisis torn, balance sheet constrained economies limited it also runs the important risk of blurring the distinction between monetary and fiscal policy.

To believe that any country issuing debt in its own currency is risk free as long as the exchange rate is flexible is astonishingly naive. For one thing, there is still inflation risk, particularly for countries with weak fiscal institutions and heavy debt burdens.

Greece has no good options, but a serious contagion risk remains to be contained in order to prevent derailment of the fiscal and growth oriented reforms in Italy and Spain.

Moreover, the risk of such a policy mistake is high, because the political economy of countries like the US may lead officials to postpone tough choices about unsustainable fiscal deficits.

But phasing in austerity more gradually, and thus back loading the adjustment, would have posed less risk to the economy s anemic recovery while maintaining a credible commitment to fiscal consolidation.

Preventing this from occurring in emerging economies requires that these countries leaders balance monetary, fiscal, and macro prudential policies in a way that enables correct pricing of risk free assets.

Both sides will have to make an effort Creditors must accept some risk, and debtors must enhance their creditworthiness through structural fiscal adjustment and reforms that improve their growth prospects.

Unfortunately, Germany resists all of these key policy measures, as it is fixated on the credit risk to which its taxpayers would be exposed with greater economic, fiscal, and banking integration.

Some European academics tried to argue that there was no need for US like fiscal transfers, because any desired degree of risk sharing can, in theory, be achieved through financial markets.

Meanwhile, the state lurches from fiscal tragedy to fiscal farce.

Fiscal consolidation was not, however, the result of formal fiscal rules.

Fiscal Follies

That would remove the serious risk that the ECB could start buying bonds on the basis of agreed fiscal packages, and then be forced to react if governments fall short on implementing them.

Rather, the problem is a polarized Congress that has taken no major economic decisions in the last few years other than missteps (like the fiscal cliff) that risk tripping the economy into recession.

This peculiar arrangement is a further major risk for economic and monetary union, to add to those of uncoordinated fiscal policies and the lack of a European equivalent of the International Monetary Fund.