Date published: Nov 2017
SUERF Policy Note, Issue No 21
by Demosthenes Ioannou and David Schäfer
European Central Bank
JEL-codes: E44, E62, E63, F36, F45, F65, G15, H63.
Keywords: Banking union, capital flows, capital markets channel, capital markets union, credit channel, cross-border banking, currency union, EMU, EFSF, EFSM, ESM, European Deposit Insurance, financial integration, fiscal policy, fiscal union, international portfolio diversification, resilience, risk-sharing, savings channel, shock absorption, Stability and Growth Pact.
The notion of risk-sharing in currency unions has recently acquired interest in policy making circles. This note links key findings from the literature to relevant euro area (EA) policies and tools. Risk-sharing in a currency union takes place mainly through the savings and capital markets channels, as well as through fiscal transfers between (member) states. Risk-sharing results in more efficient absorption of (mainly) asymmetric shocks, and can therefore support the smooth and even transmission of monetary policy. Different views emerge on whether the main risk-sharing channels are shock-absorption complements or substitutes. Recent theoretical insights suggest that the full integration of credit and capital markets does not reap the full benefits of private risk-sharing without the support of public institutions. Empirical estimates of risk-sharing suggest that the savings/credit channel accounts for most of the shock absorption capacity of the euro area, with EA loans to currency union members receiving financial assistance during the crisis providing significant consumption smoothing through this channel, and working against the pro-cyclicality imposed by markets on the net borrowing of national governments. Interpreting the literature in the EMU context also suggests that more risk-sharing through the completion of the banking union (BU), capital markets union (CMU) and a fiscal capacity would notably improve the euro area’s shock absorption capacity.
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