Risk-Sharing in the Economic and Monetary Union: Before, During and After the Crisis

This article reinterprets the euro area crisis by reviewing mechanisms to share economic risks within Economic and Monetary Union (EMU). The euro was expected to foster flexibility and convergence of national economies, and it was believed that national fiscal policy alone could address adverse economic shocks. The outcome was very different. In the first years of EMU, risk-sharing developed mainly through financial markets. Policy did little to induce flexibility or convergence and national fiscal institutions malfunctioned. The global financial crisis and the sovereign debt crisis then impaired the market-based risk-sharing mechanisms. Since flexibility or convergence had not been achieved, and national fiscal policy could not provide self-insurance, the two crises left the euro area with insufficient risk-sharing arrangements. The actions of the ECB and other public institutions can only temporarily fill this void. For EMU to be put on a sound and durable footing, market-based risk-sharing mechanisms must be restored, flexibility and convergence must be fostered, and national fiscal policy must act responsibly. New European institutions are desirable as a complement to – not as a substitute for – policy action at the national level.