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Private and Public Risk Sharing in the Euro Area

This paper investigates the contribution of private and public channels for consumption risk sharing in the euro area. In particular, it explores the role of financial integration versus official financial assistance for consumption smoothing. In addition, it presents a time-varying test which allows estimating how risk sharing has evolved since the start of the euro, including the recent great recession and European sovereign debt crisis. Our results suggest that, whereas in the early years of the euro only about a third of country-specific output shocks were smoothed, in the aftermath of the crisis almost 60% of these shocks were absorbed, therefore reducing consumption growth differentials across countries. This improvement was mostly due to a higher degree of financial integration, as reflected in particular in cross-border portfolio holdings of corporate and government bonds. Importantly, the provision of official loans to distressed governments in the wake of the crisis considerably improved risk sharing since 2010.