Abstract
AbstractThe development of effective risk sharing mechanisms is one of the main passages for the success and longevity of a monetary union. In this paper, we study risk sharing, measured as income and consumption smoothing, in the EMU. As we employ time‐varying estimations, we are able to retrieve time patterns of risk sharing for each member country and to compare them with the degree of economic asymmetry within the EMU. Other than documenting the need for stronger risk sharing mechanisms in the EMU, our results also suggest that much more attention should be dedicated to fostering homogeneity in risk sharing across member countries. We document the existence of increasing heterogeneity in the risk sharing capacity between member countries that can potentially exacerbate and amplify the impact of asymmetric shocks and further destabilize the EMU.
Highlights
The global financial crisis and the subsequent sovereign debt crisis have exposed fundamental weaknesses in the design and functioning of the EMU that had been previously overlooked
We study risk sharing dynamics in the EMU by means of the Kalman filter and evaluate how such dynamics have been linked to the degree of economic asymmetry between member countries
We study the degree of risk sharing by constructing measures of income smoothing as well as consumption smoothing (Demyanyk et al, 2008)
Summary
The global financial crisis and the subsequent sovereign debt crisis have exposed fundamental weaknesses in the design and functioning of the EMU that had been previously overlooked. We analyse income and consumption risk sharing in the EMU by comparing their dynamics with the trends in the degree of economic asymmetry between member countries. Following the global financial crisis and the sovereign debt crisis in Europe, for most of the countries in our sample the degree of asymmetry has sharply increased It has recently reached higher levels than the ones registered in the pre-euro period. This result explains how the need for risk sharing mechanisms among EMU member countries has grown in the last 10 years and why it should be one of the priorities in the EMU nowadays.
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