Fiscal Risk Sharing and Resilience to Shocks: Lessons for the euro area from the US. CEPS Working Document No 2017/07, May 2017

Alcidi, Cinzia. and Thirion, Gilles (2017) Fiscal Risk Sharing and Resilience to Shocks: Lessons for the euro area from the US. CEPS Working Document No 2017/07, May 2017. [Policy Paper]

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Abstract

The classic argument for a euro area (EA) fiscal capacity revolves around the need to “dampen the effects of asymmetric shocks”. According to authors who expound this conventional wisdom, the euro area (EA) needs a common fiscal capacity along the lines of the ‘US federal fiscal system’ because it lacks automatic stabilisers to deal with asynchronous output fluctuations. This paper provides empirical evidence to indicate that the abovementioned view largely overstates the stabilising role of US federal transfers to states. Despite the absence of a centralised EA stabiliser, the automatic stabilisers in the EA bring about a larger degree of insurance against asymmetric shocks (about 20%) than that provided by the US federal budget (11%). To some extent, this is attributable to the higher degree of market-based risk sharing in the US and to the existence of other public institutions enhancing financial stability and private risk sharing in the US. Yet we show that US federal fiscal policy appears to be primarily a stabiliser of US-wide shocks, rather than idiosyncratic shocks.

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