Essays on Monetary Unions and Insurance

Abstract

This thesis consists of two essays, linked by the theme of the provision of incentives for insurance arrangements. The first examines a prominent feature of the U.S. social safety net. Many of the welfare benefits provided by the U.S. government take the form of in-kind transfers, such as SNAP (Food Stamps), and these in-kind benefits are provided both to people who are active participants in the labor market and those who are not, such as retirees and recipients of long-term disability insurance. I show that, under very general conditions, consumption margins for agents that do not work should not be distorted in an ex ante efficient allocation in a standard dynamic Mirleesian framework. However, I then show that by adding home production to the model, and rationale for consumption distortions arises for agents that do not work, thus rationalizing the use of in-kind welfare benefits for retirees and the disabled from an efficiency perspective. The second essay turns to the crisis in the Eurozone, asking why would low debt members of a monetary union choose to bailout members with high debt? I propose a novel mechanism that explains this behavior. The central bank will try to use surprise inflation to devalue the nominal debt of member countries who are net borrowers, as this will tend to decrease consumption inequality between households in debtor countries and creditor countries. Creditor countries can forestall this costly surprise inflation by bailing out debtor countries, as this reduces between-country inequality and dampens the central bank's desire to redistribute. If countries accumulate debt in response bad shocks, the bailouts mimic a risk sharing arrangement between member countries. The model then also offers a new theory of why countries would choose to form a monetary union: a common monetary policy provides the incentives required for risk sharing.