Endogenous policy leads to inefficient risk sharing

We analyze 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 fiscal spending in an attempt to manipulate security prices. This leads to incomplete...

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Bibliographic Details
Published inReview of economic dynamics Vol. 7; no. 3; pp. 758 - 787
Main Authors Celentani, Marco, Conde-Ruiz, J.Ignacio, Desmet, Klaus
Format Journal Article
LanguageEnglish
Published Orlando Elsevier Inc 01.07.2004
Academic Press
Subjects
Complete markets
Economic policy
Economic theory
Economics
Efficiency
Endogenous policy
Fiscal policy
Market
Mathematical models
Risk
Risk sharing
Studies
Complete markets
Risk sharing
Endogenous policy
Efficiency
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Summary:We analyze 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 fiscal spending in an attempt to manipulate security prices. 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, 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.
Bibliography:ObjectType-Article-2
SourceType-Scholarly Journals-1
ObjectType-Feature-1
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ISSN:1094-2025
1096-6099
DOI:10.1016/j.red.2003.12.001