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Regional Debt in Monetary Unions: Is it Inflationary?

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  • Cooper, R.
  • Kempf, H.
  • Peled, D.

Abstract

This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with no inflationary consequences? Or will the circulation of region debt induce monetization by a central bank? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of the holdings of the regional debt. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of policy measures within a monetary union.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 186.

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Length: 31 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:bfr:banfra:186

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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
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Related research

Keywords: Monetary Union ; Inflation tax ; Seigniorage ; Public debt.;

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References

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  1. Russell Cooper & Hubert Kempf & Dan Peled, 2005. "Is it is or is it ain't my obligation? Regional debt in a fiscal federation," Working Papers 0507, Federal Reserve Bank of Dallas.
  2. Carlos E. Zarazaga, 1993. "Hyperinflations and moral hazard in the appropriation of seigniorage," Working Papers 93-26, Federal Reserve Bank of Philadelphia.
  3. Fernando Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign risk and secondary markets," Economics Working Papers 998, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2009.
  4. Russell Cooper & Hubert Kempf, 2004. "Overturning Mundell: Fiscal Policy in a Monetary Union," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 371-396, 04.
  5. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
  6. V. V. Chari & Patrick J. Kehoe, 2002. "Time Consistency and Free-Riding in a Monetary Union," NBER Working Papers 9370, National Bureau of Economic Research, Inc.
  7. V. V. Chari & Patrick J. Kehoe, 1998. "On the need for fiscal constraints in a monetary union," Working Papers 589, Federal Reserve Bank of Minneapolis.
  8. Russell W. Cooper & Hubert Kempf., 2001. "Dollarization and the conquest of hyperinflation in divided societies," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-12.
  9. Beetsma, Roel M.W.J. & Debrun, Xavier, 2007. "The new stability and growth pact: A first assessment," European Economic Review, Elsevier, vol. 51(2), pages 453-477, February.
  10. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  11. Aizenman, Joshua, 1992. "Competitive Externalities and the Optimal Seigniorage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 61-71, February.
  12. Dixit, Avinash & Lambertini, Luisa, 2003. "Symbiosis of monetary and fiscal policies in a monetary union," Journal of International Economics, Elsevier, vol. 60(2), pages 235-247, August.
  13. Beetsma, Roel & Uhlig, Harald, 1999. "An Analysis of the Stability and Growth Pact," Economic Journal, Royal Economic Society, vol. 109(458), pages 546-71, October.
  14. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
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Citations

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Cited by:
  1. repec:hal:cesptp:halshs-00497430 is not listed on IDEAS
  2. Russell Cooper, 2012. "Exit from a Monetary Union through Euroization: Discipline without Chaos," NBER Working Papers 17908, National Bureau of Economic Research, Inc.
  3. Anna Sokolova, 2013. "Fiscal Limits and Monetary Policy: Default vs. Inflation," HSE Working papers WP BRP 39/EC/2013, National Research University Higher School of Economics.
  4. Russell Cooper & Hubert Kempf & Dan Peled, 2010. "Insulation Impossible: Fiscal Spillovers in a Monetary Union," Economics Working Papers ECO2010/20, European University Institute.
  5. Sokolova, A., 2014. "Sovereign Risk and Monetary Policy," Journal of the New Economic Association, New Economic Association, vol. 21(1), pages 56-82.
  6. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
  7. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
  8. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.

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