Risk Sharing and EMU

Working Paper: CEPR ID: DP4460

Authors: Jacques Melitz

Abstract: What are the prospects that risk sharing in EMU will ever attain the levels in the US? So far as the risk sharing in the US depends on interregional transfers through the budget of the federal government, those prospects are poor. So far as the risk sharing in the US takes place though market channels, they are much better. The Paper addresses the theory and evidence on the subject. The evidence would indicate that EMU still lags far behind the US as regards the pooling of risks through portfolio diversification. But there already seems to be little to distinguish the euro area from the US concerning the ability to borrow to smooth shocks. Thus, some extra risk sharing should already be taking place in the euro area through this channel. How much? Further, there is also evidence that the progress of European economic and monetary integration over the last decade has increased the symmetry of business cycles. This evidence is difficult to interpret. It could even be a sign of remaining capital-market imperfections. One of the issues in the Paper is the adequacy of the general framework that Asdrubali, Sørensen and Yosha have proposed for dealing with all of these questions.

Keywords: current account balance; EMU; fiscal federalism; portfolio diversification; risk sharing

JEL Codes: F02; F15

Causal Claims

Cause	Effect
risk sharing in the EMU (F36)	risk sharing in the US (G52)
public transfers in the US (H79)	smoothing of regional shocks (R11)
adverse shocks to a region (R11)	decreased tax contributions and increased federal assistance (H29)
market channels in the US (L81)	risk sharing in the US (G52)
risk sharing in the EMU (F36)	inadequate borrowing mechanisms (H74)
progress of European economic and monetary integration (F36)	increased symmetry of business cycles (F44)
remaining capital market imperfections (G19)	symmetry of business cycles (F44)