Working Paper: CEPR ID: DP1670
Authors: Bente Sørensen; Oved Yosha
Abstract: We measure the amount of income insurance and cross-sectional consumption smoothing (lending and borrowing) achieved within subgroups of states, such as regions or clubs, e.g. the club of rich states. We find that there is as much income insurance between, as well as within, regions. By contrast, consumption smoothing occurs mainly within regions but not between regions, suggesting that capital markets transcend regional barriers while credit markets are regional in their nature. Smoothing within the club of rich states is accomplished mainly via capital markets whereas consumption smoothing is dominant within the club of poor states. The fraction of a shock to gross state product smoothed by the federal tax-transfer system is the same for various regions and other clubs of states. We calculate the scope for consumption smoothing within various regions and clubs, finding that most gains from risk sharing can be achieved within US regions. Since a considerable fraction of shocks to gross state product are smoothed within regions, we conclude that existing markets achieve a substantial fraction of the potential welfare gains from interstate income and consumption smoothing. Nonetheless, non-negligible welfare gains may be obtained from further improvement of risk sharing institutions.
Keywords: capital markets; consumption smoothing; credit markets; federal government; insurance; regional risk sharing; welfare gains
JEL Codes: D52; E21; E32; E44; E60; F36; G15; R50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Shocks to GSP (F69) | Consumption smoothing (D15) |
| Shocks to GSP (F69) | Income smoothing (D15) |
| Capital markets facilitate income smoothing across regions (G19) | Income smoothing (D15) |
| Consumption smoothing predominantly occurs within regions (D15) | Consumption smoothing (D15) |
| Federal taxes and transfers smooth shocks across state groups (H29) | Consumption smoothing (D15) |
| Rich states rely more on capital markets (P19) | Income smoothing (D15) |
| Poor states rely more on consumption smoothing mechanisms (D15) | Consumption smoothing (D15) |
| Improvements in risk-sharing institutions (G23) | Welfare gains (D69) |