Reducing Risk While Sharing it: A Fiscal Recipe for the EU at the Time of COVID-19

29 Pages Posted: 30 Oct 2020

See all articles by Nicoletta Batini

Nicoletta Batini

International Monetary Fund (IMF)

Francesco Lamperti

Scuola Superiore Sant'Anna di Pisa - Institute of Economics and LEM; Fondazione Eni Enrico Mattei (FEEM)

Andrea Roventini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM); Observatoire Fran├žais des Conjonctures Economiques (OFCE)

Date Written: September 1, 2020

Abstract

The COVID-19 lockdowns have brought about the need of large fiscal responses in all European countries. However, countries across Europe are differently equipped to respond to the shock due to differences in economic conditions and fiscal space. We build on the model by Berger et al. (2019) to compare gains from alternative mechanisms of EU fiscal integration in the presence of moral hazard. We show that any EU response strategy to the COVID-19 crisis excluding mutual financial support to member countries lacks credibility. Some form of fiscal risk sharing is indeed better than none, especially in presence of increasing sovereign default risk of some EU member countries. The moral hazard created by risk sharing can be hedged by introducing some form of fiscal delegation to Brussels. The desirable level of delegation, however, depends on its costs. When these are low, risk sharing and delegation are substitutes and it is optimal to opt for high delegation and low risk sharing. On the contrary, when delegation costs are high, centralization and risk sharing are complements and both are needed. Proposed arrangements at the EU level in response to the COVID-19 shock seem to reflect these basic insights by rotating around a combination of fiscal risk sharing and delegation in the form of fiscal spending conditionality.

Keywords: Fiscal union, Financial crises, Public debt, Moral hazard, COVID-19, WP, tag0, graphic tag0, risk sharing, EU bond, EU risk

JEL Classification: H10, H70, H81, E62, G01, H63, G18, I12

Suggested Citation

Batini, Nicoletta and Lamperti, Francesco and Roventini, Andrea, Reducing Risk While Sharing it: A Fiscal Recipe for the EU at the Time of COVID-19 (September 1, 2020). IMF Working Paper No. 20/181, Available at SSRN: https://ssrn.com/abstract=3721206

Nicoletta Batini (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Francesco Lamperti

Scuola Superiore Sant'Anna di Pisa - Institute of Economics and LEM ( email )

Institute of Economics
Piazza Martiri della Liberta, n. 33
Pisa, Pisa 56127
Italy

Fondazione Eni Enrico Mattei (FEEM) ( email )

C.so Magenta 63
Milano, 20123
Italy

Andrea Roventini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta', 33-I-56127
Pisa
Italy

Observatoire Fran├žais des Conjonctures Economiques (OFCE)

69 Quai d'Orsay
Paris 75004
France

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