Working Paper: CEPR ID: DP2104
Authors: Jan Fidrmuc
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: disintegration; median voter; risk sharing; optimum currency areas; central and eastern europe
JEL Codes: E62; F2; H73
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| region-specific shocks (R11) | stability of unions (J58) |
| correlation of shocks (C10) | decision to secede (H77) |
| persistence of shocks (E32) | decision to secede (H77) |
| negative correlation of shocks + high persistence (E32) | fragility of integration (F02) |
| risk sharing benefits (D16) | shocks negatively correlated and transient (E32) |
| political limits on fiscal transfers (H77) | shocks persistent and/or large (E32) |