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Endogenous Policy Leads to Inefficient Risk Sharing

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  • Marco Celentani

    (Universidad Carlos III)

  • J. Ignacio Conde-Ruiz

    (FEDEA)

  • Klaus Desmet

    (Universidad Carlos III)

Abstract

We analyze 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 fiscal spending in an attempt to manipulate security prices. 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, 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. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2003.12.001
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 7 (2004)
Issue (Month): 3 (July)
Pages: 758-787

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Handle: RePEc:red:issued:v:7:y:2004:i:3:p:758-787

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Keywords: Endogenous policy; Complete markets; Efficiency; Risk sharing;

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References

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  1. Canova, Fabio & Ravn, Morten O, 1996. "International Consumption Risk Sharing," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 573-601, August.
  2. Persson, Torsten & Tabellini, Guido, 1996. "Federal Fiscal Constitutions: Risk Sharing and Redistribution," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(5), pages 979-1009, October.
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Citations

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Cited by:
  1. Marco Celentani & J. Ignacio Conde-Ruiz & Klaus Desmet, . "Inflation in open economies with complete markets," Working Papers 2004-12, FEDEA.
  2. José Tavares, 2012. "Fiscal Union Consensus Design Under The Threat Of Autarky," 2012 Meeting Papers, Society for Economic Dynamics 202, Society for Economic Dynamics.
  3. Andrea Mattozzi, 2010. "Policy Uncertainty, Electoral Securities, And Redistribution," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(1), pages 45-71, 02.
  4. Luque, Jaime & Morelli, Massimo & Tavares, José, 2011. "Fiscal Union Consensus Design under the Risk of Autarky," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8552, C.E.P.R. Discussion Papers.
  5. Juan Prieto & Juan Gabriel Rodríguez & Rafael Salas, . "Polarization, Inequality and Tax Reforms," Working Papers 2003-23, FEDEA.
  6. Andrea Mattozzi, 2008. "Can we insure against political uncertainty? Evidence from the U.S. stock market," Public Choice, Springer, Springer, vol. 137(1), pages 43-55, October.

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