DP2104 Stochastic Shocks and Incentives for (Dis)Integration
|Publication Date:||March 1999|
|Keyword(s):||Central and Eastern Europe, Disintegration, Median Voter, Optimum Currency Areas, Risk Sharing|
|JEL(s):||E62, F2, H73|
|Programme Areas:||Transition Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=2104|
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.