The Optimal Design of a Fiscal Union

55 Pages Posted: 10 Apr 2013 Last revised: 6 Dec 2015

See all articles by Mikhail Dmitriev

Mikhail Dmitriev

Florida State University - Department of Economics

Jonathan Hoddenbagh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS)

Date Written: November 2015

Abstract

We study cooperative and non-cooperative fiscal policy in a multi-country model where asset markets are segmented and countries face terms of trade externalities. We show that the optimal form of fiscal cooperation, or fiscal union, is defined by the Armington elasticity of substitution between the products of different countries. We prove that members of a fiscal union should: (1) harmonize tax rates when the Armington elasticity is low in order to ameliorate terms of trade externalities; and (2) send fiscal transfers across countries when the Armington elasticity is high in order to improve risk-sharing. For standard calibrations, the welfare gains from tax harmonization are as high as 0.3% of permanent consumption for countries both inside and outside of a currency union. The welfare gains from fiscal transfers are close to zero for countries outside of a currency union, but rise to between 0.5% (France) and 3.6% (Greece) of permanent consumption for countries inside a currency union.

Keywords: Fiscal Union, Monetary Union, Open Economy Macroeconomics, International Macroeconomics

JEL Classification: E52, F42

Suggested Citation

Dmitriev, Mikhail and Hoddenbagh, Jonathan, The Optimal Design of a Fiscal Union (November 2015). Available at SSRN: https://ssrn.com/abstract=2247454 or http://dx.doi.org/10.2139/ssrn.2247454

Mikhail Dmitriev

Florida State University - Department of Economics ( email )

Tallahassee, FL 30306-2180
United States

Jonathan Hoddenbagh (Contact Author)

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

HOME PAGE: http://https://www2.bc.edu/jonathan-hoddenbagh/

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