Risk Sharing and Emu

Abstract

What are the prospects that risk sharing in EMU will ever attain the levels in the U.S.? So far, as the risk sharing in the U.S. depends on interregional transfers through the budget of the federal government, those prospects are poor. So far, as the risk sharing in the U.S. 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 U.S. as regards the pooling of risks through portfolio diversification. But there already seems to be little to distinguish the euro area from the U.S. 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, Sorensen and Yosha have proposed for dealing with all of these questions.

Keywords: Risk sharing, EMU, fiscal federalism, portfolio diversification, current account balance

JEL Classification: F02, F15