Political Economy of Fiscal Unions
26 Pages Posted: 30 Jul 2013
Date Written: July 29, 2013
Abstract
I formulate a political-economy model of a fiscal union where the threat of secession imposes a limit on fiscal redistribution between regions. I argue that the trade-off between implementing the region’s preferred fiscal policy and benefiting from inter-regional risk sharing depends on the nature of economic shocks. Specifically both correlation of shocks across regions and their persistence over time are important. The gains from inter-regional risk sharing are potentially large when shocks are negatively correlated and temporary. In contrast, unions with negatively correlated permanent shocks are likely to prove politically unviable.
Keywords: fiscal federalism, risk sharing, disintegration, median voter, optimum currency areas
JEL Classification: D720, F590, H770
Suggested Citation: Suggested Citation