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Political Devolution without Fiscal Devolution

  • Andrew Hughes Hallett

    ()

    (Vanderbilt University and CEPR)

Using a conventional model, this paper examines the conditions under which it is possible to stabilise both the output (inflation) cycle and the budget deficit/surplus of a regional economy in a wider currency union. We find that it is never possible. But we can approximate that result (for example, by limiting budgetary instability when the cycle is smoothed) if the product and labour markets are suitably flexible. Conversely, if fiscal policy is restricted, output and inflation volatility will be extended unless all shocks are supply shocks, compared to the case where there is some fiscal autonomy. Attempts at stabilisation in this situation would lead to an unstable political equilibrium. These results are important because they show what can be expected from fiscal restraints like the Stability Pact or tax harmonisation in the Eurozone; and from fiscal autonomy at the subnational level in older unions. Calibrating the results for the EU and UK respectively, we find that denying autonomy to the regions of the UK might be rather costly in terms of performance. But imposing tax harmonisation at the EU level would not.

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File URL: http://www.accessecon.com/pubs/VUECON/vu05-w05.pdf
File Function: First version, 2005
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Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0505.

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Date of creation: Mar 2005
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Handle: RePEc:van:wpaper:0505
Contact details of provider: Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

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  1. Brunila, Anne & Buti, Marco & in't Veld , Jan, 2002. "Cyclical stabilisation under the Stability and Growth Pact: How effective are automatic stabilisers?," Research Discussion Papers 6/2002, Bank of Finland.
  2. Gunter Coenen & Volker Wieland, 2002. "Inflation dynamics and international linkages: a model of the United States, the euro area, and Japan," International Finance Discussion Papers 745, Board of Governors of the Federal Reserve System (U.S.).
  3. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  4. Michael J. Artis & Marco Buti, 2000. "Close to Balance or in Surplus. A Policy Maker’s Guide to the Implementation of the Stability and Growth Pact," EUI-RSCAS Working Papers 28, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
  5. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  6. Ramey, Garey & Ramey, Valerie A, 1995. "Cross-Country Evidence on the Link between Volatility and Growth," American Economic Review, American Economic Association, vol. 85(5), pages 1138-51, December.
  7. Demertzis, Maria & Hughes Hallett, Andrew, 1999. "An Independent Central Bank Faced With Elected Governments," CEPR Discussion Papers 2219, C.E.P.R. Discussion Papers.
  8. Hughes Hallett, Andrew & Viegi, Nicola, 2003. "Labour Market Reform and the Effectiveness of Monetary Policy in EMU," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 18, pages 726-749.
  9. Buti, Marco & Franco, Daniele & Ongena, Hedwig, 1998. "Fiscal Discipline and Flexibility in EMU: The Implementation of the Stability and Growth Pact," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 81-97, Autumn.
  10. Kose, M. Ayhan & Prasad, Eswar S. & Terrones, Marco E., 2006. "How do trade and financial integration affect the relationship between growth and volatility?," Journal of International Economics, Elsevier, vol. 69(1), pages 176-202, June.
  11. Dellas, Harris & Tavlas, George, 2003. "Wage Rigidity and Monetary Union," CEPR Discussion Papers 3679, C.E.P.R. Discussion Papers.
  12. David Gruen & Tim Robinson & Andrew Stone, 2002. "Output Gaps in Real Time: Are They Reliable Enough to Use for Monetary Policy?," RBA Research Discussion Papers rdp2002-06, Reserve Bank of Australia.
  13. George A. Akerlof & William T. Dickens & George L. Perry, 2000. "Near-Rational Wage and Price Setting and the Long-Run Phillips Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(1), pages 1-60.
  14. Bean, Charles, 1998. "The New UK Monetary Arrangements: A View from the Literature," Economic Journal, Royal Economic Society, vol. 108(451), pages 1795-1809, November.
  15. Hallett, Andrew Hughes & Jensen, Svend E. Hougaard & Richter, Christian, 2005. "The European economy at the cross roads: Structural reforms, fiscal constraints, and the Lisbon Agenda," Research in International Business and Finance, Elsevier, vol. 19(2), pages 229-250, June.
  16. repec:sae:niesru:v:164:y::i:1:p:90-99 is not listed on IDEAS
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