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Fiscal Federalism in Continuous Time Stochastic Economies

  • Amador, Joao L. M.

This paper examines the different types of incentives that countries face when deciding to take part in a federal fiscal system. The optimal degree of participation depends on the structural parameters of the economy and on the properties of the federal fiscal system. Firstly, the paper examines the case of federal fiscal systems that work as simple insurance arrangements. Secondly, a mixed insurance and redistribution system is considered. Thirdly, fiscal system participation is added as a parameter of the utility function. Finally, the paper examines the case of a fiscal federation that responds to shocks on the terms of trade. The models are developed in a continuous time stochastic framework and simple closed form solutions are obtained. Simulation methods are used to illustrate the stationary equilibrium path of variables. The paper concludes that risk sharing is a strong motive for taking part in a fiscal federation. Fiscal system participation increases when the country benefits from redistribution or when participation is a parameter of the utility function. Finally, it is shown that there are incentives to participate in fiscal federations that respond to shocks on the terms of trade. In this case, the higher the volatility of the shocks on the terms of trade, the lower the variance of the capital stock growth rate in the optimum.

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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp383.

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Length: 48 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:unl:unlfep:wp383
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  1. Persson, Torsten & Tabellini, Guido, 1996. "Federal Fiscal Constitutions: Risk Sharing and Redistribution," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 979-1009, October.
  2. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
  3. Asdrubali, Pierfederico & Sorensen, Bent E & Yosha, Oved, 1996. "Channels of Interstate Risk Sharing: United States 1963-1990," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1081-1110, November.
  4. Bayoumi, Tamim & Eichengreen, Barry, 1992. "Shocking Aspects of European Monetary Unification," CEPR Discussion Papers 643, C.E.P.R. Discussion Papers.
  5. Mario Forni & Lucrezia Reichlin, 1999. "Risk and potential insurance in Europe," ULB Institutional Repository 2013/10145, ULB -- Universite Libre de Bruxelles.
  6. Sachs, Jeffrey & Sala-i-Martin, Xavier, 1992. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States," CEPR Discussion Papers 632, C.E.P.R. Discussion Papers.
  7. von Hagen, Jürgen, 1998. "Fiscal policy and intranational risk-sharing," ZEI Working Papers B 13-1998, ZEI - Center for European Integration Studies, University of Bonn.
  8. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, June.
  9. Persson, Torsten & Tabellini, Guido, 1996. "Federal Fiscal Constitutions: Risk Sharing and Moral Hazard," Econometrica, Econometric Society, vol. 64(3), pages 623-46, May.
  10. De Grauwe, Paul & Vanhaverbeke, Wim, 1991. "Is Europe an Optimum Currency Area? Evidence from Regional Data," CEPR Discussion Papers 555, C.E.P.R. Discussion Papers.
  11. Maurice Obstfeld & Giovanni Peri, 1998. "Regional non-adjustment and fiscal policy," Economic Policy, CEPR;CES;MSH, vol. 13(26), pages 205-259, 04.
  12. von Hagen, Jurgen & Hammond, George W, 1998. "Regional Insurance against Asymmetric Shocks: An Empirical Study for the European Community," The Manchester School of Economic & Social Studies, University of Manchester, vol. 66(3), pages 331-53, June.
  13. Bayoumi, Tamim & Masson, Paul R., 1995. "Fiscal flows in the United States and Canada: Lessons for monetary union in Europe," European Economic Review, Elsevier, vol. 39(2), pages 253-274, February.
  14. Sorensen, Bent E. & Yosha, Oved, 1998. "International risk sharing and European monetary unification," Journal of International Economics, Elsevier, vol. 45(2), pages 211-238, August.
  15. Sergio Nardis & Alessandro Goglio & Marco Malgarini, 1996. "Regional specialization and shocks in Europe: Some evidence from regional data," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 132(2), pages 197-214, September.
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