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Endogenous policy leads to inefficient risk sharing

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  • Marco Celentani
  • J. Ignacio Conde
  • Klaus Desmet

Abstract

We analyze risk sharing and fiscal spending in a two-region model with complete markets. Fiscal policy determines tax rates for each state of nature. When fiscal policy is decentralized, it can be used to affect prices of securities. To manipulate prices to their beneffit, regions choose pro-cyclical fiscal spending. This leads to incomplete risk sharing, despite the existence of complete markets and the absence of aggregate risk. When a fiscal union centralizes fiscal policy, securities prices can no longer be manipulated and complete risk sharing ensues. If regions are homogeneous, median income residents of both regions prefer the fiscal union. If they are heterogeneous, the median resident of the rich region prefers the decentralized setting.

Suggested Citation

  • Marco Celentani & J. Ignacio Conde & Klaus Desmet, 2002. "Endogenous policy leads to inefficient risk sharing," Economics Working Papers 593, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2003.
    • Handle: RePEc:upf:upfgen:593
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    Cited by:

    1. Andrea Mattozzi, 2010. "Policy Uncertainty, Electoral Securities, And Redistribution," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(1), pages 45-71, February.
    2. Andrea Mattozzi, 2008. "Can we insure against political uncertainty? Evidence from the U.S. stock market," Public Choice, Springer, vol. 137(1), pages 43-55, October.
    3. Marco Celentani & J. Conde-Ruiz & Klaus Desmet, 2007. "Inflation in Open Economies with Complete Markets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 31(2), pages 271-291, May.
    4. Giovannini, Alessandro & Ioannou, Demosthenes & Stracca, Livio, 2022. "Public and private risk sharing: friends or foes? The interplay between different forms of risk sharing," Occasional Paper Series 295, European Central Bank.
    5. Morelli, Massimo & Tavares, José & Luque, Jaime, 2011. "Fiscal Union Consensus Design under the Risk of Autarky," CEPR Discussion Papers 8552, C.E.P.R. Discussion Papers.
    6. Luigi Guiso & Helios Herrera & Massimo Morelli & Tommaso Sonno, 2018. "Global Crises and Populism: the Role of Eurozone Institutions," EIEF Working Papers Series 1806, Einaudi Institute for Economics and Finance (EIEF), revised May 2018.
    7. Luque, Jaime & Morelli, Massimo & Tavares, José, 2014. "A volatility-based theory of fiscal union desirability," Journal of Public Economics, Elsevier, vol. 112(C), pages 1-11.
    8. José Tavares, 2012. "Fiscal Union Consensus Design Under The Threat Of Autarky," 2012 Meeting Papers 202, Society for Economic Dynamics.
    9. Juan Prieto & Juan Gabriel Rodríguez & Rafael Salas, "undated". "Polarization, Inequality and Tax Reforms," Working Papers 2003-23, FEDEA.

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    More about this item

    Keywords

    Interregional risk-sharing; complete markets;

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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