Decentralized Fiscal Policy in an Imperfectly Competitive Federal Economy

Abstract

This paper analyzes the efficacy and desirability of decentralized fiscal policies, in a two-region federal economy, with monopolistic competition in local product markets, unionized local labor markets, and a nationwide competitive sector. Local governments are utilitarian and use balanced-budget policies to provide public goods in their own region. They also may be subjected to constitutional limits to public spending, taking the form of cash-planning. In this case, unilateral fiscal policies increase price and possible wage mark-ups, yielding crowding out and employment losses in the other region. Uncoordinated local policies lead to overexpansion. The central government should intervene to encourage coordination. Copyright 1997 by Blackwell Publishers Ltd and The Victoria University of Manchester