Abstract
Fiscal unions often use fiscal transfers to counter asymmetric shocks, but such transfers may be politically controversial. I present a model of a two-region fiscal union with region-specific shocks where the threat of secession imposes a limit on fiscal redistribution between regions.
I show that both correlation of shocks across regions and their persistence over time are important for political support for integration. The gains from inter-regional risk sharing are potentially large when shocks are negatively correlated and temporary.
In contrast, unions with negatively correlated permanent shocks are likely to be fragile. (C) 2015 The Author. Published by Elsevier B.V.