Working Paper: CEPR ID: DP1170
Authors: Jurgen von Hagen; George W. Hammond
Abstract: The loss of the exchange rate as an independent policy instrument implied by EMU has spurred calls for an insurance scheme as a buffer against temporary, asymmetric shocks to national income. We study the potential properties of such a system using historical data from the 12 EC economies. An insurance scheme with reasonable properties can be implemented on the basis of a fairly complex econometric formula. Simplifying the computation of the transfers severely worsens the performance of the system, however. Forcing the system to balance financially is not a critical constraint. The simulations show that stabilizing asymmetric shocks around a common trend may amplify the univariate variance of GDP for some member countries.
Keywords: monetary union; fiscal federalism; business cycles; stabilization policy
JEL Codes: E32; E52; E63; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| loss of the exchange rate as a policy instrument (F31) | increased national output and employment variability (E39) |
| insurance mechanism (G52) | stabilizing national income against shocks (E63) |
| complex econometric procedure (C51) | satisfactory system that generates no permanent transfers (D51) |
| simplifying the design of the transfer scheme (F16) | significant drawbacks (D62) |
| enforcing budget neutrality (H61) | performance of insurance mechanism (G22) |
| insurance against asymmetric shocks (G52) | variability of output and employment over time (E32) |