Matthias Kredler (UC3M)
RISK-SHARING WITH A CENTRAL
AUTHORITY: FREE-RIDING, LACK OF
COMMITMENT, AND BAIL-OUTS
Resumen: Agents with independent risks (regions) often create unions and delegate re-distributive power to a central institution (center), which provides risk-sharing through transfers. How- ever, there is the risk that regions free-ride on each other; this risk may be exacerbated when the center cannot commit to future policies. This problem is particularly present in fiscal federations. We study a differential game of two regions that make savings decisions and a benevolent center that sets transfers but lacks commitment. When transfers are costless, we find two kinds of equilibria. In the first, the center immediately expropriates the less- liked region. In the second, the center provides a smooth transfer schedule and regions’ bankruptcy can be avoided; this second equilibrium exists only in the knife-edge case that the center puts exactly the same welfare weights on both regions. When transfers are costly, one region always ends up bankrupt and the center provides what resembles a bailout: as the poor regions enters bankruptcy, there is an upward jump in transfers to the poor region that coincides with a downward discontinuity in the poor region’s consumption. Joint work with Ruben Veiga Duarte.
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