Risk sharing in the euro zone

In a currency area, monetary policy can no longer respond to country-specific shocks, and another method is therefore needed to respond to these shocks (which is called risk sharing: shocks are shared between all countries in the curre ncy area instead of remaining located in the country where they appear). In the euro zone, many countries reject an introduction of a federal budget, and risk sharing cannot therefore result from fiscal federalism. This leaves two forms of risk sharing: A banking union; this involves implementing all measures that protect a country’s banks from a deterioration in the country’s economic situation: creation of pan-European banks; deposit insurance and bank crisis resolution funds at the euro-zone level; ability for banks to raise financing in all euro-zone countries; diversification of banks’ bond portfolios. If this is achieved, banks in a troubled country will remain in a position to lend, which is stabilising; A capital markets union; this means that savers/investors in euro-zone countries hold portfolios of financial assets diversified across all euro-zone countries. If there is a recession in one country, the prices of this country’ financial assets fall, but portfolio diversification protects the country’s savers against this loss .