Risk sharing towards the European fiscal union

The aim of this research is to estimate a two-country Dynamic Stochastic General Equilibrium Model (DSGE) for the euro area, core and periphery. The estimation is performed with Bayesian techniques using eleven macroeconomic time series. The model implements an automatic fiscal transfer mechanism, able to deal with idiosyncratic shocks affecting the two economies. The mechanism is able to improve the aggregate welfare in the economy, by reducing consumption variability and increasing cross-country risk sharing. Simulating the model with estimated parameters, we reach the conclusion that an optimal fiscal sharing mechanism should absorb 70% of idiosyncratic shocks when agents are credit constrained. The implementation of a risk sharing system would lead to greater fiscal coordination, marking a first step towards greater fiscal integration in the euro area.