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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. repec:sae:niesru:v:164:y::i:1:p:90-99 is not listed on IDEAS
  2. 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.
  3. Artis, Michael J & Buti, Marco, 2000. ""Close to Balance or in Surplus": A Policy Maker's Guide to the Implementation of the Stability and Growth Pact," CEPR Discussion Papers 2515, C.E.P.R. Discussion Papers.
  4. Ray C. Fair, 1998. "Estimated Stabilization Costs of the EMU," National Institute Economic Review, National Institute of Economic and Social Research, vol. 164(1), pages 90-99, April.
  5. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
  6. 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.
  7. 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.
  8. 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.
  9. Ray Barrell & Karen Dury, 2000. "Choosing the Regime: Macroeconomic Effects of UK Entry into EMU," Journal of Common Market Studies, Wiley Blackwell, vol. 38(4), pages 625-644, November.
  10. Gunter Coenen & Volker W. 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.).
  11. 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.
  12. 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.
  13. Andrew Hughes Hallett & Svend E. Hougaard Jensen, 2003. "On the Role of Labour Market Reform for the Enlargement of a Monetary Union," CESifo Economic Studies, CESifo, vol. 49(3), pages 355-379.
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