ABSTRACT
This chapter analyses the role of net fiscal transfers in mitigating the impact of regional shocks on subnational public finances in federations. It focuses on the extent of risk-sharing - an issue that has figured front and center in the discussion regarding euro area institutions in recent years and, relatedly, whether a federal system with a central budget or equivalent risk-sharing mechanisms would achieve better insurance against macroeconomic shocks than a system without it. Disentangling the respective roles of redistribution, stabilization, and risk-sharing is complicated as in most federations fiscal transfers play them simultaneously. The chapter offers some methodological refinements in the estimation of risk-sharing and redistribution motives of fiscal transfers. It reviews the standard two-step approach that has been used in the literature - where redistribution and risk-sharing motives are estimated separately and proposes a new, more efficient one-step approach. This chapter reviews existing empirical approaches for measuring the impact of fiscal transfers on redistribution and insurance.
