Working Paper: NBER ID: w23235
Authors: Patrick J. Kehoe; Elena Pastorino
Abstract: Do sophisticated international financial markets obviate the need for an active union-wide authority to orchestrate fiscal transfers between countries to provide adequate insurance against country-specific economic fluctuations? We argue that they do. Specifically, we show that in a benchmark economy with no international financial markets, an activist union-wide authority is necessary to achieve desirable outcomes. With sophisticated financial markets, however, such an authority is unnecessary if its only goal is to provide cross-country insurance. Since restricting the set of policy instruments available to member countries does not create a fiscal externality across them, this result holds in a wide variety of settings. Finally, we establish that an activist union-wide authority concerned just with providing insurance across member countries is optimal only when individual countries are either unable or unwilling to pursue desirable policies.
Keywords: Financial Markets; Fiscal Unions; Insurance; Economic Fluctuations
JEL Codes: E0; E5; E6; F62; F33; F36; F38; F42; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sophisticated international financial markets (G15) | necessity of unionwide fiscal authority (H69) |
| lack of international financial markets (F30) | necessity of unionwide fiscal authority (H69) |
| restrictions on policy instruments (E61) | fiscal externality (D62) |
| self-interested national governments (F52) | preference for unionwide authority (J58) |
| commitment capabilities of unionwide authority (J53) | optimal role of unionwide authority (J58) |
| commitment capabilities of member countries (F53) | optimal role of unionwide authority (J58) |