Balanced-budget rules and risk-sharing in a fiscal union

This paper addresses the following question: What are the implications of the asymmetry of balanced-budget rules for interregional risk sharing in a fiscal union? We investigate our research question in a two-region, open economy DSGE model that is augmented with the public-sector features of a federal state. The analysis demonstrates that the asymmetry of balanced-budget rules is detrimental for the risk sharing in the union. The degree of risk sharing is a function of the public good productivity, specification of the technology process, and distribution of productivity shocks in the fiscal union.