Endogenous Policy Leads to Inefficient Risk-Sharing

Marco Celentani (), Klaus Desmet and J. Ignacio Conde-Ruiz

No 3866, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We analyse risk-sharing and endogenous fiscal spending in a two-region model with sequentially complete markets. Fiscal policy is determined by majority voting. When policy setting is decentralized, regions choose pro-cyclical fiscal spending in an attempt to manipulate security prices to their benefit. 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, security prices can no longer be manipulated and complete risk sharing ensues. If regions are relatively homogeneous, median income residents of both regions prefer the fiscal union. If they are relatively heterogeneous, the median resident of the rich region prefers the decentralized setting.

Keywords: Endogenous policy; Complete markets; Efficiency; Risk-sharing (search for similar items in EconPapers)
JEL-codes: C72 D50 D72 E61 (search for similar items in EconPapers)
Date: 2003-04
New Economics Papers: this item is included in nep-geo and nep-pol
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Citations: View citations in EconPapers (2)

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Journal Article: Endogenous Policy Leads to Inefficient Risk Sharing (2004)
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