Income insurance: a theoretical exercise with empirical application for the euro area

The recent crisis has shown how economic shocks can lead to considerable and persistent cyclical divergences in the euro area. Successful monetary unions have generally been backed by fiscal arrangements providing income insurance against shocks. This paper reviews the potential issues, the underlying trade-offs and the necessary theoretical conditions to make an income insurance scheme workable, and provides an empirical application for the euro area. It also discusses ‘good’ design features, arguing that such schemes should focus on large shocks and exert a moderating effect during boom times, as well as provide cushioning against adverse shocks.

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