Risk Sharing and the Adoption of the Euro

TL;DR

This paper empirically assesses the impact of euro adoption on risk sharing and consumption smoothing among euro area countries, revealing a reduction especially in peripheral nations due to decreased private credit risk sharing.

Contribution

It introduces a novel empirical approach using synthetic control and output variance decomposition to evaluate risk sharing changes post-euro adoption.

Findings

Euro adoption reduced risk sharing and consumption smoothing.

The decrease is mainly driven by peripheral countries.

Private credit channels are significantly affected.

Abstract

This paper empirically evaluates whether adopting a common currency has changed the level of consumption smoothing of euro area member states. We construct a counterfactual dataset of macroeconomic variables through the synthetic control method. We then use the output variance decomposition of Asdrubali, Sorensen and Yosha (1996) on both the actual and the synthetic data to study if there has been a change in risk sharing and through which channels. We find that the euro adoption has reduced risk sharing and consumption smoothing. We further show that this reduction is mainly driven by the periphery countries of the euro area who have experienced a decrease in risk sharing through private credit.