Absorbing Shocks

In this paper we investigate the interplay between national rainy-day funds and supranational transfers in a fiscal union. We find that moral hazard leads to lower contributions to a rainy day fund with a fiscal union present, and further that the higher the fiscal transfer, the lower will be the contributions to the rainy-day fund. The optimal size of the fiscal union trades-off the ex-post insurance provided by the union and the moral hazard which reduces national ex-ante preparation for stabilization policies. Optimally, the insurance provided by the fiscal union should be lower (1) the more effective is own-fiscal policy; (2) the more the presence of the fiscal union reduces rainy-day fund savings; (3) the lower is the relative probability of recession; and (4) the lower is the utility gain of redistribution in the union. We also find that commitment to a transfer policy is essential. A fiscal union that is prone to break the rules on transfers negatively impacts the ex-ante contributions to individual members' rainy day funds.

Austerity · Economic policy · Economics · Fiscal imbalance · Fiscal policy · Fiscal union · Macroeconomics · Monetary economics · Moral hazard · Political science · Recession · Redistribution (election) · Economic Policies and Impacts · Fiscal Policies and Political Economy · Global Financial Crisis and Policies

• Coping with extreme events

  Timothy J Goodspeed•Regional Studies•2023

  Add to list