Endogenous Policy Leads to Inefficient Risk-Sharing

35 Pages Posted: 5 Jun 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: April 2003

Abstract

We analyse risk-sharing and endogenous 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, security prices can no longer be manipulated and complete risk sharing ensues. If regions are relatively homogeneous, median income residents of both regions prefer the fiscal union. If they are relatively heterogeneous, the median 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 (April 2003). CEPR Discussion Paper No. 3866. Available at SSRN: https://ssrn.com/abstract=413400

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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