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Grupo de Estudos Monetários e Financeiros

Estudos do GEMF, N.º 02 de 2003


Output Smoothing in EMU and OECD: Can We Forego Government Contribution?

A Risk Sharing Approach

Carlos Fonseca Marinheiro
Faculty of Economics at the University of Coimbra, and the Catholic University of Leuven

This paper analyses the smoothing of asymmetric shocks to output for a sample of OECD countries. The research finds no evidence of large differences in the patterns of risk sharing for the 19 OECD countries, the EU-15 or euro-area countries, for the period 1970-1999. However, there were shown to be considerable differences between the euro-area and the successful monetary union of the USA: the euro-area showed a much lower insurance of asymmetric shocks than the US states. In the US federation, 75% of the asymmetric shocks to output were smoothed in the period 1964-1990. However, in the euro-area only 44% of such shocks were not passed onto consumption in the period 1970-1999. Until increasing economic integration in Europe does not lead to a substantial decrease in the incidence of idiosyncratic shocks, such shocks may impose non-negligible welfare costs.
Due to a large contribution from the public sector to risk sharing, especially to smooth out more persistent shocks, it does not seem likely that private capital markets can easily replace the government, in the near future, in providing a sufficient degree of risk sharing in the euro-area. Even if capital markets become as integrated in the euro-area as they were in the US federation in the period 1964-1990, the amount of shocks left unsmoothed will still be 1.8 times larger than in the US federation. As there are no substantial differences between the patterns of risk sharing for the different samples considered, an eventual enlargement of the euro-area to include the UK, Denmark and Sweden is not likely to pose additional risk sharing problems for the euro-zone.

JEL classification: E21; E62; F15; F36.

Keywords: EMU; Output smoothing; Risk sharing; International capital markets; Economic integration.

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