Fiscal Delegation in a Monetary Union with Decentralized Public Spending

63 Pages Posted: 6 Sep 2013

See all articles by Henrique S. Basso

Henrique S. Basso

Banco de España

James S. Costain

Banco de España - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: September 5, 2013

Abstract

This paper studies the effects of delegating control of sovereign debt issuance to an independent authority in a monetary union where public spending decisions are decentralized. The model assumes that no policy makers are capable of commitment to a rule. However, consistent with Rogoff (1985) and with the recent history of central banking, it assumes that an institution may be designed to have a strong preference for achieving some clear, simple, quantitative policy goal.

Following Beetsma and Bovenberg (1999), we show that in a monetary union where a single central bank interacts with many member governments, debt is excessive relative to a social planner’s solution. We extend their analysis by considering the establishment of an independent fi scal authority (IFA) mandated to maintain long-run budget balance. We show that delegating sovereign debt issuance to an IFA in each member state shifts down the time path of debt, because this eliminates aspects of deficit bias inherent in democratic politics. Delegating to a single IFA at the union level lowers debt further, because common pool problems across regions’ deficit choices are internalized.

The establishment of a federal government with fiscal powers over the whole monetary union would be less likely to avoid excessive deficits, because only the second mechanism mentioned above would apply. Moreover, the effective level of public services would be lower, if centralized spending decisions are less informationally efficient.

Keywords: fiscal authority, delegation, decentralization, monetary union, sovereign debt

JEL Classification: E61, E62, F41, H63

Suggested Citation

Basso, Henrique S. and Costain, James S., Fiscal Delegation in a Monetary Union with Decentralized Public Spending (September 5, 2013). Banco de Espana Working Paper No. 1311, Available at SSRN: https://ssrn.com/abstract=2321086 or http://dx.doi.org/10.2139/ssrn.2321086

Henrique S. Basso (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

James S. Costain

Banco de España - Research Department ( email )

Alcala 50
28014 Madrid
Spain

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