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Fiscal Delegation in a Monetary Union with Decentralized Public Spending

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  • Henrique S. Basso
  • James S. Costain

Abstract

In a monetary union, the interaction between several governments and a single central bank is plagued by several sources of deficit bias, including common pool problems. Each government has strong preferences over local spending and taxation but suffers only part of the costs of union-wide inflation and higher interest rates, creating a tendency towards excessive debt. Motivated by the evident failure of fiscal rules to restrain debt in the European context, this paper analyzes an alternative fiscal regime in which the control of sovereign debt issurance is delegated to an independent authority, while public spending decisions remain decentralized. Using a symmetric perfect-foresight model, we compare the long-run policy biases affecting a typical country across different institutional arrangements. Establishing an independent fiscal authority tends to reduce debt via three distinct channels: first, the debt aversion induced by its mandate; second, its greater patience, compared to an elected institution; and third, the internalization of common pool problems, if the authority is established at the union-wide level. Furthermore, we show that fiscal delegation is more effective in restraining debt, and more informationally efficient, than the establishment of a federal government which would centralize fiscal decisions.

Suggested Citation

  • Henrique S. Basso & James S. Costain, 2016. "Fiscal Delegation in a Monetary Union with Decentralized Public Spending," CESifo Working Paper Series 5775, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_5775
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    References listed on IDEAS

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    Cited by:

    1. Henrique S. Basso & James Costain, 2016. "Fiscal Delegation in a Monetary Union with Decentralized Public Spending," CESifo Economic Studies, CESifo, vol. 62(2), pages 256-288.
    2. Corsetti, Giancarlo & Dedola, Luca & Jarociński, Marek & Maćkowiak, Bartosz & Schmidt, Sebastian, 2016. "Macroeconomic stabilization, monetary-fiscal interactions, and Europe’s monetary union," Working Paper Series 1988, European Central Bank.
    3. Guilherme Bandeira, 2018. "Fiscal transfers in a monetary union with sovereign risk," Working Papers 1807, Banco de España;Working Papers Homepage.

    More about this item

    Keywords

    fiscal authority; delegation; decentralization; monetary union; sovereign debt;

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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