Abstract
When is a fiscal union appropriate for a monetary union? In a monetary union without fiscal externalities, when local fiscal authorities have an informational advantage over a central fiscal authority in terms of their knowledge of countries’ preferences for government spending, a decentralized fiscal regime dominates a centralized one. Our novel result is that in the presence of fiscal externalities across countries, however, a decentralized fiscal regime is optimal for small monetary unions, whereas a centralized fiscal regime is optimal for large ones. These results shed new light on the debate on fiscal integration within the EU and its enlargement.
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