Decentralized government and regional income insurance
One advantage of a decentralized system of government is that it allows government expenditure and taxation to better suit local preferences for public goods. On the other hand, if income is uncertain, a centralized system that incorporates interregional transfers allows regions to share consumption risk associated with region-specific shocks. Previous studies have compared decentralized and centralized systems using single period models in which all shocks are effectively permanent. This paper shows that when output shocks are temporary, if local governments borrow in periods with negative shocks and save in periods with positive shocks, a decentralized regime can stabilize income as effectively as a centralized regime. When output shocks are both temporary and permanent, the tradeoff between decentralized and centralized regimes depends on the difference in preferences for the public good across regions, the probability that disturbances to output are temporary, and the degree to which shocks are correlated across regions. Copyright Springer-Verlag 2004
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Volume (Year): 38 (2004)
Issue (Month): 1 (03)
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