Decentralized fiscal policy in an imperfectly competitive federal economy

In this paper we analyse the efficacy and desirability of decentralized fiscal policies, in a two-region federal economy, with monopolistic competition in local product markets, unionized local labour markets and a nationwide competitive sector. Local governments are utilitarian and use balanced-budget policies to provide public goods in their own region. They may also be subjected to constitutional limits to public spending, taking the form of cash planning. In this case, unilateral fiscal policies increase price and possibly 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.