Risk sharing within a common currency area. Crosscountry risk sharing arrangements take on added importance in a common currency area. Within a currency union, countries cannot use monetary policy to respond to country-specific shocks, since the common monetary policy reflects the (weighted) fundamentals of all of the members and not that of any one country. Likewise, wage and price rigidities and limited labor mobility across countries, whether due to legal constraints like the immobility of pension benefits, or cultural factors, like language differences, can reduce the ability of a country to adjust to country-specific shocks. In principle, domestic fiscal policies are a natural tool in a currency union to manage country-specific shocks. But their scope to act counter-cyclically can sometimes be limited, as was seen in the euro area during the Great Recession: credit markets froze up, making it difficult both for sovereigns and private agents to use borrowing to smooth consumption. To some extent, liquidity provision by the European Central Bank and official crosscountry flows (through the TARGET2 settlement mechanism) helped fill the gap left by private credit markets (Cecchetti, McCauley, and McGuire, 2012). But crosscountry fiscal arrangements might be a powerful additional instrument to support risk sharing in these circumstances.

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.This paper investigates the medium-term behavior of output following banking crises, and its association with pre-and post-cr isis conditions and policies. W e find that output tends to be depressed substantially follo wing banking crises, with no rebound to the precrisis trend. However, growth does eventually te nd to return to its pre crisis rate, with substantia l crosscountry variation in outcomes. The depressed path of output typically results from reductions of roughly equal proportions in the em ployment rate, the capital-to-labor ratio, and total factor produ ctivity. Initial cond itions that are strongly as sociated with m edium-run outpu t losses include the short-run change in output, the occurrence of a joint banking-and-currency crisis, and a high precrisis level of investm ent. Short-run fiscal and m onetary stim ulus is associated with smaller medium-run deviations of output and growth from the precrisis trend.

advice. This note will also provide background for the 2013 EU Financial Sector Assessment Program. DISCLAIMER: This Staff Discussion Note represents the views of the authors and does not necessarily represent IMF views or IMF policy. The views expressed herein should be attributed to the authors and not to the IMF, its Executive Board, or its management. Staff Discussion Notes are published to elicit comments and to further debate.

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