Assessing the Euro Area’s Shock-Absorption Capacity Risk sharing, consumption smoothing and fiscal policy. CEPS Special Report No. 146 / September 2016

Alcidi, Cinzia. and Thirion, Gilles (2016) Assessing the Euro Area’s Shock-Absorption Capacity Risk sharing, consumption smoothing and fiscal policy. CEPS Special Report No. 146 / September 2016. UNSPECIFIED.

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Abstract

this paper assesses both the state of play and the future capacity of the EMU to respond and adapt to asymmetric shocks. The objective is to provide a basis upon which to gauge the potential value added of a European Unemployment Benefits Scheme (EUBS), against the background of the recent plans for the Banking Union, the Capital Markets Union and the reform of the fiscal governance framework. We find that the capacity of the system to deal with asymmetric shocks (and in principle reduce their occurrence) is likely to increase due to these changes, but it will remain limited in the medium term and certainly lower than in the US. We also argue that given the broad pro-cyclicality of fiscal policy, the idea that national policies alone can deal alone with asymmetric shocks is not realistic. Lastly, we maintain that an ex-ante fiscal insurance mechanism can provide some degree of income smoothing and is likely to catalyse market insurance. Fiscal and market insurance can reduce the role of credit and borrowing, which until now has been the main channel for shock absorption in the euro area but also the least effective in times of crisis. We conclude that, from a macroeconomic point of view, an EUBS is a useful tool to improve shock absorption capacity and is not mutually exclusive with market risk sharing.

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