Stochastic Shocks and Incentives for (Dis)Integration

Jan Fidrmuc

No 2104, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: I present a political economy model of limits to regional redistribution under the threat of secession. The model depicts a union composed of two regions with centralized fiscal policy. The key feature is the trade off between the benefits of secession embodied by autonomous fiscal policy, and the benefits of integration --- efficiency gains and risk sharing. I argue that previously stable unions may disintegrate in response to specific patterns of region-specific output shocks. The decision on secession depends on correlation and persistence of shocks. Integration is sustainable if the shocks are positively correlated and/or transient. On the other hand, the combination of negative correlation and high persistence of the shocks makes integration fragile. Benefits from risk sharing are greatest when shocks are negatively correlated and transient.

Keywords: Central and Eastern Europe; Disintegration; Median Voter; Optimum Currency Areas; Risk Sharing (search for similar items in EconPapers)
JEL-codes: E62 F2 H73 (search for similar items in EconPapers)
Date: 1999-03
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Citations: View citations in EconPapers (12)

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