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Risk sharing in the euro area

Jacopo Cimadomo (), Sebastian Hauptmeier, Alessandra Anna Palazzo and Alexander Popov ()

Economic Bulletin Articles, 2018, vol. 3

Abstract: This article discusses the concept of risk sharing, which generally refers to the notion that economic agents, such as households and firms, attempt to insure their consumption streams against fluctuations in the business cycle of their country, i.e. they try to “smooth out” changes in their consumption resulting from economic shocks. The article then considers what proportion of an economic shock in the euro area can be smoothed, and compares this with the situation in the United States. While a comparison of the degree of risk sharing between the euro area and the United States needs to be seen against the background of different institutional and political architectures, it nevertheless offers potentially interesting economic insights. The article shows that, while in the euro area around 80% of a shock to GDP growth in a given country remained unsmoothed over the period 1999-2016, thus resulting in sizeable differences in consumption growth across countries, in the United States at most 40% of a shock to state-specific GDP was unsmoothed over the same period. The article also evaluates the relative importance of the main risk sharing channels, i.e. the credit, capital and fiscal channels, as well as the role of European institutions. It shows that, in the euro area, risk sharing takes place mainly via the capital channel, i.e. through cross-border holdings of financial assets. Finally, the article puts the empirical results into the perspective of the ongoing debate on enhancing the institutional architecture of Economic and Monetary Union (EMU). It calls for euro area countries to make their economies, banking sectors and public finances less vulnerable to macroeconomic shocks. The article explains how efficient and integrated financial markets are a core prerequisite for effective private risk sharing in the euro area. It also shows how the euro area would benefit from a central fiscal stabilisation function to support national economic stabilisers in the presence of large economic shocks and thereby make EMU more resilient. JEL Classification: E21, E62, F15, F36

Keywords: economic integration; EMU; international capital markets; output smoothing; risk sharing (search for similar items in EconPapers)
Date: 2018-05
Note: 352854
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