Risk Sharing in a Politically Divided Monetary Union

Abstract

We document stark asynchronicity across U.S. states, particularly across groups of states whose populations have voted consistently Democrat or consistently Republican in national elections; and we show that their risk-sharing channels differ substantially. However, we find that these groups of states – even swing states, where the role of fiscal flows is small (on par with Europe's) – do share risk. Indeed, we halve previous estimates of states' residual risk by using new data to account for sharing risk through changes in population, prices, and durable goods consumption. These findings indicate that political differences alone do not preclude macroeconomic risk sharing within a monetary union.

Keywords: Monetary union, Optimal currency area, Currency union, Political division

JEL Classification: F33, F45