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Endogenous policy leads to inefficient risk sharing

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  • Marco Celentani
  • J. Ignacio Conde
  • Klaus Desmet

Abstract

We analyze risk sharing and fiscal spending in a two-region model with complete markets. Fiscal policy determines tax rates for each state of nature. When fiscal policy is decentralized, it can be used to affect prices of securities. To manipulate prices to their beneffit, regions choose pro-cyclical fiscal spending. 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 homogeneous, median income residents of both regions prefer the fiscal union. If they are heterogeneous, the median resident of the rich region prefers the decentralized setting.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 593.

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Date of creation: Jan 2002
Date of revision: Mar 2003
Handle: RePEc:upf:upfgen:593

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Web page: http://www.econ.upf.edu/

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Keywords: Interregional risk-sharing; complete markets;

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Cited by:
  1. 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, vol. 51(1), pages 45-71, 02.
  2. Marco Celentani & J. Conde-Ruiz & Klaus Desmet, 2007. "Inflation in Open Economies with Complete Markets," Economic Theory, Springer, vol. 31(2), pages 271-291, May.
  3. José Tavares, 2012. "Fiscal Union Consensus Design Under The Threat Of Autarky," 2012 Meeting Papers 202, Society for Economic Dynamics.
  4. Mattozzi, Andrea, 2004. "Can we insure against political uncertainty? Evidence from the U.S. Stock Market," Working Papers 1207, California Institute of Technology, Division of the Humanities and Social Sciences.
  5. Juan Prieto & Juan Gabriel Rodríguez & Rafael Salas, . "Polarization, Inequality and Tax Reforms," Working Papers 2003-23, FEDEA.
  6. Luque, Jaime & Morelli, Massimo & Tavares, José, 2011. "Fiscal Union Consensus Design under the Risk of Autarky," CEPR Discussion Papers 8552, C.E.P.R. Discussion Papers.

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