Risk Sharing towards the European Fiscal Union

D'Imperio, Paolo (2015) Risk Sharing towards the European Fiscal Union. [Conference Proceedings] (Submitted)

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Abstract

This research estimates a two-country Dynamic Stochastic General Equilibrium Model (DSGE) for the euro area Core and Periphery. The estimation is done with Bayesian techniques using eleven macroeconomic time series. The model implements an automatic fiscal transfer mechanism, able to deal with idiosyncratic shocks affecting the two economies. The mechanism is able to improve the aggregate welfare in the economy, by reducing consumption variability and increasing cross-country risk sharing. Simulating the model with estimated parameters, we reach the conclusion that an optimal fiscal sharing mechanism should absorb 70% of idiosyncratic shocks when agents are credit constrained. The risk sharing mechanism under analysis is able to deal with EMU cyclical heterogeneity and external imbalances. The implementation of a risk sharing system would lead to a greater fiscal coordination, marking a first step towards greater fiscal integration in the euro area.

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