Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States

Xavier X. Sala-i-Martin and Jeffrey D. Sachs

in M. B. Canzoneri, V. Grilli and P. R. Masson editors, "Establishing a Central Bank: Issues in Europe and Lessons from the U.S.", Cambridge University Press, 1992.


The main aim of this paper is to estimate the extent to which the Federal Government of the United States insures member states against regional income shocks. Between one-third and one-half of the initial shock to a region is absorbed by the Federal Government. Taxes respond more strongly to regional imbalances than do transfers. The main mechanism at work is the federal income tax system, which implies that the stabilization process is automatic rather than specifically designed each time there is a cyclical movement in income. Some economists may argue that this regional insurance scheme, provided by the Federal Government, is an important reason why the US system of fixed exchange rates has survived without major difficulties. According to this view, Europeans who look to the United States as a model for Europe should seriously consider the creation (or expansion) of a federal fiscal system at the same time as they create a European Central Bank that issues a unified European currency.


Foreign Exchange [Exchange Rates; Intervention; Foreign Exchange Reserves], F310. International Monetary Arrangements and Institutions, F330. Macroeconomic Aspects of Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation, E620. Taxation and Subsidies: Externalities; Redistributive Effects, H230. Exchange Rates and Markets-- Theory and Studies, 4314. International Monetary Arrangements, 4320. Fiscal Theory; Empirical Studies Illustrating Fiscal Theory, 3212. Welfare Theory-- Externalities, 0244. Welfare Theory--Redistribution Analyses, 0243.