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Federal Fiscal Constitutions ; Part I: Risk Sharing and Moral Hazard

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  • Persson, T.
  • Tabellini, G.

Abstract

Inspired by the current European developments, we study equilibrium fiscal policy under alternative "federal" arrangements. Our model has two levels of government. Local policy redistributes across individuals and affects the probability of aggregate shocks, whereas federal policy shares international risk. Policies are chosen under majority rule. There is a tradeoff between risk-sharing and moral hazard: federal risk-sharing can induce local governments to enact policies that increase local risk. We analyze this tradeoff under alternative fiscal constitutions. In particular, we contrast a vertically ordered system like the EC with a horizontally ordered federal system like the US. These alternative arrangements create different incentives for policymakers and voters, and give rise to different political equilibria. Under appropriate institutions, centralization of functions and power can mitigate the moral hazard problem.

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Bibliographic Info

Paper provided by Stockholm - International Economic Studies in its series Papers with number 519.

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Length: 38 pages
Date of creation: 1992
Date of revision:
Handle: RePEc:fth:stocin:519

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Keywords: fiscal policy;

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References

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  1. Bureau, Dominique & Champsaur, Paul, 1992. "Fiscal Federalism and European Economic Unification," American Economic Review, American Economic Association, vol. 82(2), pages 88-92, May.
  2. Tabellini, Guido & Alesina, Alberto, 1990. "Voting on the Budget Deficit," American Economic Review, American Economic Association, vol. 80(1), pages 37-49, March.
  3. Grandmont, Jean-Michel, 1978. "Intermediate Preferences and the Majority Rule," Econometrica, Econometric Society, vol. 46(2), pages 317-30, March.
  4. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  5. Xavier Sala-i-Martin & Jeffrey Sachs, 1991. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States," NBER Working Papers 3855, National Bureau of Economic Research, Inc.
  6. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  7. Wildasin, David E, 1990. "Budgetary Pressures in the EEC: A Fiscal Federalism Perspective," American Economic Review, American Economic Association, vol. 80(2), pages 69-74, May.
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Cited by:
  1. Caillaud, B. & Jullien, B. & Picard, P., 1996. "National vs European incentive policies: Bargaining, information and coordination," European Economic Review, Elsevier, vol. 40(1), pages 91-111, January.
  2. Bolton, Patrick & Roland, Gerard & Spolaore, Enrico, 1996. "Economic theories of the break-up and integration of nations," European Economic Review, Elsevier, vol. 40(3-5), pages 697-705, April.
  3. Agnello, Luca & Sousa, Ricardo M., 2009. "The determinants of public deficit volatility," Working Paper Series 1042, European Central Bank.
  4. Fausto Hernández Trillo & Alberto Díaz Cayeros & Rafael Gamboa González, 2002. "Fiscal Decentralization in Mexico: The Bailout Problem," Research Department Publications 3143, Inter-American Development Bank, Research Department.
  5. Lejour, A.M., 1995. "Cooperative and competitive policies in the EU: The European Siamese twin?," Discussion Paper 1995-20, Tilburg University, Center for Economic Research.

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