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Political Economy of Fiscal Unions

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  • Jan Fidrmuc

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.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2013/wp-cesifo-2013-07/cesifo1_wp4344.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4344.

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Date of creation: 2013
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Handle: RePEc:ces:ceswps:_4344

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Keywords: fiscal federalism; risk sharing; disintegration; median voter; optimum currency areas;

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  1. Hepp, Ralf & von Hagen, Jürgen, 2010. "Interstate risk sharing in Germany: 1970-2006," ZEI Working Papers, ZEI - Center for European Integration Studies, University of Bonn B 03-2010, ZEI - Center for European Integration Studies, University of Bonn.
  2. Becker, Sascha O. & Hoffmann, Mathias, 2006. "Intra- and international risk-sharing in the short run and the long run," European Economic Review, Elsevier, Elsevier, vol. 50(3), pages 777-806, April.
  3. Fidrmuc, Jan & Horvath, Julius & Fidrmuc, Jarko, 1999. "Stability of monetary unions: Lessons from the break-up of Czechoslovakia," ZEI Working Papers, ZEI - Center for European Integration Studies, University of Bonn B 17-1999, ZEI - Center for European Integration Studies, University of Bonn.
  4. Alesina, Alberto & Perotti, Roberto, 1998. "Economic Risk and Political Risk in Fiscal Unions," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 108(449), pages 989-1008, July.
  5. Kessler, Anke & Luelfesmann, Christoph & Myers, Gordon M, 2009. "The Architecture of Federations: Constitutions, Bargaining, and Moral Hazard," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7244, C.E.P.R. Discussion Papers.
  6. Fidrmuc, Jan, 2000. "Political support for reforms: Economics of voting in transition countries," European Economic Review, Elsevier, Elsevier, vol. 44(8), pages 1491-1513, August.
  7. Michel Le Breton & Shlomo Weber, 2003. "The Art of Making Everybody Happy: How to Prevent a Secession," IMF Staff Papers, Palgrave Macmillan, vol. 50(3), pages 4.
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