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Political Devolution without Fiscal Devolution

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  • Andrew Hughes Hallett

    (Vanderbilt University and CEPR)

Abstract

Using a conventional model, this paper examines the conditions under which it is possible to stabilise both the output (inflation) cycle and the budget deficit/surplus of a regional economy in a wider currency union. We find that it is never possible. But we can approximate that result (for example, by limiting budgetary instability when the cycle is smoothed) if the product and labour markets are suitably flexible. Conversely, if fiscal policy is restricted, output and inflation volatility will be extended unless all shocks are supply shocks, compared to the case where there is some fiscal autonomy. Attempts at stabilisation in this situation would lead to an unstable political equilibrium. These results are important because they show what can be expected from fiscal restraints like the Stability Pact or tax harmonisation in the Eurozone; and from fiscal autonomy at the subnational level in older unions. Calibrating the results for the EU and UK respectively, we find that denying autonomy to the regions of the UK might be rather costly in terms of performance. But imposing tax harmonisation at the EU level would not.

Suggested Citation

  • Andrew Hughes Hallett, 2005. "Political Devolution without Fiscal Devolution," Vanderbilt University Department of Economics Working Papers 0505, Vanderbilt University Department of Economics.
  • Handle: RePEc:van:wpaper:0505
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    References listed on IDEAS

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    2. Hallett, Andrew Hughes & Jensen, Svend E. Hougaard & Richter, Christian, 2005. "The European economy at the cross roads: Structural reforms, fiscal constraints, and the Lisbon Agenda," Research in International Business and Finance, Elsevier, vol. 19(2), pages 229-250, June.
    3. Michael J. Artis & Marco Buti, 2000. "‘Close‐to‐Balance or in Surplus’: A Policy‐Maker's Guide to the Implementation of the Stability and Growth Pact," Journal of Common Market Studies, Wiley Blackwell, vol. 38(4), pages 563-591, November.
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    6. Demertzis, Maria & Hughes Hallett, Andrew & Viegi, Nicola, 2004. "An independent central bank faced with elected governments," European Journal of Political Economy, Elsevier, vol. 20(4), pages 907-922, November.
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    9. Andrew Hughes Hallett & Svend E. Hougaard Jensen, 2003. "On the Role of Labour Market Reform for the Enlargement of a Monetary Union," CESifo Economic Studies, CESifo Group, vol. 49(3), pages 355-379.
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    Cited by:

    1. James Foreman-Peck & Laurian Lungu, 2009. "Fiscal devolution and dependency," Applied Economics, Taylor & Francis Journals, vol. 41(7), pages 815-828.
    2. James Foreman-Peck & Laurian Lungu & Patrick Minford, 2000. "Fiscal Devolution in a Small Open Regional Economy," Regional and Urban Modeling 283600029, EcoMod.

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    More about this item

    Keywords

    Business cycle volatility; budget stability; regional autonomy; market flexibility;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • R13 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies

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