Income and Consumption Smoothing among US States: Regions or Clubs?
We quantify the amount of cross-sectional income and consumption smoothing achieved within subgroups of states, such as regions or clubs, e.g. the club of rich states. We find that there is much income smoothing between as well as within regions. By contrast, consumption smoothing occurs mainly within regions but not between regions. This suggests that capital markets transcend regional barriers while credit markets are regional in their nature. Smoothing within the club of rich states is accomplished mainly via capital markets whereas consumption smoothing is dominant within the club of poor states. The fraction of a shock to gross state products smoothed by the federal tax-transfer system is the same for various regions and other clubs of states. We calculate the scope for consumption smoothing within various regions and clubs, finding that most gains from risk sharing can be achieved within US regions. Since a considerable fraction of shocks to gross state product are smoothed within regions, we conclude that existing markets achieve a substantial fraction of the potential welfare gains from interstate income and consumption smoothing. Nonetheless, non-negligible welfare gains may be obtained from further improvement of risk sharing institutions.
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