This paper investigates whether fiscal-deficit harmonisation is a necessary condition for the efficient functioning of a common market. Using a two-country DSGE model with cross-border factor mobility, trade in goods and services, and endogenous risk premia, we simulate asymmetric deficit shocks under alternative institutional arrangements. Empirical calibration draws on the experience of the EU, MERCOSUR, and the East African Community.

Findings on uncoordinated deficits:

We find that, absent a fully-fledged fiscal union, uncoordinated deficits generate significant beggar-thy-neighbour effects: relative risk premia widen, capital reallocates toward the more prudent jurisdiction, and temporary demand spill-overs amplify output volatility in the high-deficit country.

Neutralising externalities:

These externalities, however, are largely neutralised when three instruments are in place:

(i) a jointly guaranteed safe asset that prevents sovereign-bond market segmentation,

(ii) cyclically adjusted deficit ceilings enforced by a supranational fiscal council, and

(iii) an automatic transfer mechanism that cushions asymmetric shocks.

Welfare implications:

When all three instruments operate, harmonisation of headline deficits yields only marginal welfare gains relative to the status-quo heterogeneity.

Conclusion:

The results suggest that the policy debate should shift from numerical convergence of deficits to the design of robust risk-sharing and enforcement mechanisms.