Fiscal Transfers without Moral Hazard?

Roel Beetsma, Simone Cima, Jacopo Cimadomo

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

Recent debate has focused on the introduction of a central stabilization capacity as a completing element of the Economic and Monetary Union. Its main objective would be to contribute to cushioning country-specific economic shocks, especially when national fiscal stabilizers are run down. There are two main potential objections to such schemes proposed so far: first, they may lead to moral hazard, i.e., weaken the incentives for sound fiscal policies and structural reforms. Second, they may generate permanent transfers among countries. Here we present a scheme that is relatively free from moral hazard, because the transfers are based on changes in world trade in the various industrial sectors. These changes can be considered as largely exogenous, hence independent from an individual government’s policy. Therefore, the scheme is better protected against manipulation compared with other schemes based on domestic variables (e.g., unemployment). Our scheme works as follows: if a sector is hit by a negative shock at the world market level, then a country with an economic structure that is skewed toward this sector receives a temporary transfer from the other countries. We show that the transfers generated by our scheme are countercyclical. In addition, since transfers are based on deviations from trends in sectoral export value-added, the danger of permanent transfers from one set of countries to the other countries is effectively ruled out. Finally, we show that the transfers are robust to different sectoral aggregation and revisions in the underlying export data.
Original languageEnglish
JournalInternational Journal of Central Banking
Volume17
Issue number3
Pages (from-to)95-153
Number of pages59
ISSN1815-4654
Publication statusPublished - Sep 2021

Cite this