Asymmetric Shocks and Risk Sharing in a Monetary Union: Updated Evidence and Policy Implications for Europe
41 Pages Posted: 5 Aug 2004
Date Written: June 2004
We find that risk sharing in the European Union (EU) has been increasing over the past decade due to increased cross-ownership of assets across countries. Industrial specialization has also been increasing over the last decade, and we conjecture that risk sharing plays an important causal effect by allowing countries to specialize without being subject to higher income risk even though the variability of output may increase. We believe that lower trade barriers may not have played a dominant causal role during this decade, because the effect of lower trade barriers has probably already played itself out. We further find that the asymmetry of GDP fluctuations in the EU has declined steeply over the last two decades. This may be due to economic policies becoming more similar as countries were adjusting fiscal policy in order to meet the Maastricht criteria; however, a similar result was found for U.S. states so the finding may be due to a different nature of the shocks to the world economy in the 1990s. We expect to see a further rise in risk sharing between EU countries, accompanied by more specialization. The resulting increase in GDP asymmetry should be minor, however, and will have small welfare costs, because increased risk sharing should lower income (GNP) asymmetry.
Keywords: Financial integration, regional specialization, international portfolio diversification, income insurance
JEL Classification: F15, F20, F36, F43
Suggested Citation: Suggested Citation