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Fiscal Unions

Listed author(s):
  • Ivan Werning
  • Emmanuel Farhi

We study cross-country risk sharing as a second-best problem for members of a currency union using an open economy model with nominal rigidities and provide two key results. First, we show that if financial markets are incomplete, the value of gaining access to any given level of aggregate risk sharing is greater for countries that are members of a currency union. Second, we show that even if financial markets are complete, privately optimal risk sharing is constrained inefficient. A role emerges for government intervention in risk sharing both to guarantee its existence and to influence its operation. The constrained efficient risk sharing arrangement can be implemented by contingent transfers within a fiscal union. We find that the benefits of such a fiscal union are larger, the more asymmetric the shocks affecting the members of the currency union, the more persistent these shocks, and the less open the member economies. Finally we compare the performance of fiscal unions and of other macroeconomic stabilization instruments available in currency unions such as capital controls, government spending, fiscal deficits, and redistribution.

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File URL: http://www.nber.org/papers/w18280.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18280.

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Date of creation: Aug 2012
Handle: RePEc:nbr:nberwo:18280
Note: EFG IFM ME
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  1. Anton Korinek, 2011. "The New Economics of Prudential Capital Controls: A Research Agenda," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(3), pages 523-561, August.
  2. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
  3. Olivier Jeanne & Anton Korinek, 2010. "Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach," American Economic Review, American Economic Association, vol. 100(2), pages 403-407, May.
  4. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  5. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  6. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-660, June.
  7. Sibert, Anne, 1992. "Government finance in a common currency area," Journal of International Money and Finance, Elsevier, vol. 11(6), pages 567-578, December.
  8. Bottazzi, Laura & Manasse, Paolo, 2002. "Credibility and Seigniorage in a Common Currency Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 1034-1046, November.
  9. Joshua Aizenman, 1989. "The Competitive Externalities and the Optimal Seignorage," NBER Working Papers 2937, National Bureau of Economic Research, Inc.
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