Endogenous Policy Leads to Inefficient Risk Sharing

UPF Economics and Business Working Paper No. 593

33 Pages Posted: 18 Jul 2003

See all articles by Marco Celentani

Marco Celentani

Universidad Carlos III de Madrid - Department of Economics

J. Ignacio Conde-Ruiz

Foundation for Applied Economic Research (FEDEA)

Klaus Desmet

Southern Methodist University (SMU); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2003

Abstract

We analyze risk sharing and fiscal spending in a two-region model with sequentially complete markets. Fiscal policy is determined by majority voting. When policy setting is decentralized, regions choose pro-cyclical fiscal spending in an attempt to manipulate security prices to their benefit. This leads to incomplete risk sharing, despite the existence of complete markets and the absence of aggregate risk. When a fiscal union centralizes fiscal policy, securities prices can no longer be manipulated and complete risk sharing ensues. If regions are relatively homogeneous, the median income resident of the rich region prefers the decentralized setting.

Keywords: Endogenous policy, complete markets, efficiency, risk sharing

JEL Classification: C72, D50, D72, E61

Suggested Citation

Celentani, Marco and Conde-Ruiz, J. Ignacio and Desmet, Klaus, Endogenous Policy Leads to Inefficient Risk Sharing (March 2003). UPF Economics and Business Working Paper No. 593. Available at SSRN: https://ssrn.com/abstract=311550 or http://dx.doi.org/10.2139/ssrn.311550

Marco Celentani (Contact Author)

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain
+34-91-624 9546 (Phone)
+34-91-624 9875 (Fax)

J. Ignacio Conde-Ruiz

Foundation for Applied Economic Research (FEDEA) ( email )

Jorge Juan 46
Madrid, 28001
Spain
+34 91 435 9020 (Phone)
+34 91 577 9575 (Fax)

Klaus Desmet

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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