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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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Web page: http://www.banque-france.fr/
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Keywords: Monetary Union ; Inflation tax ; Seigniorage ; Public debt.;

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References

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  1. V. V. Chari & Patrick J. Kehoe, 2010. "Time Inconsistency and Free-Riding in a Monetary Union," Levine's Working Paper Archive 506439000000000084, David K. Levine.
  2. 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.
  3. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  4. Russell Cooper & Hubert Kempf & Dan Peled, 2005. "Is It Is or Is It Ain't My Obligation? Regional Debt in a Fiscal Federation," NBER Working Papers 11655, National Bureau of Economic Research, Inc.
  5. Fernando A Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," Working Papers 306, Barcelona Graduate School of Economics.
  6. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
  7. Aizenman, Joshua, 1992. "Competitive Externalities and the Optimal Seigniorage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 61-71, February.
  8. Russell Cooper & Hubert Kempf, 2004. "Overturning Mundell: Fiscal Policy in a Monetary Union," Review of Economic Studies, Oxford University Press, vol. 71(2), pages 371-396.
  9. 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.
  10. Carlos E. Zarazaga, 1993. "Hyperinflations and moral hazard in the appropriation of seigniorage," Working Papers 93-26, Federal Reserve Bank of Philadelphia.
  11. 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.
  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 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.
  14. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
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Cited by:
  1. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2014. "Coordination and Crisis in Monetary Unions," NBER Working Papers 20277, National Bureau of Economic Research, Inc.
  2. Russell Cooper & Hubert Kempf & Dan Peled, 2009. "Insulation impossible: fiscal spillovers in a monetary union," Globalization and Monetary Policy Institute Working Paper 30, Federal Reserve Bank of Dallas.
  3. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.
  4. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
  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. 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.
  7. Betty Daniel & Christos Shiamptanis, 2008. "Fiscal Risk in a Monetary Union," Discussion Papers 08-12, University at Albany, SUNY, Department of Economics.
  8. Russell Cooper, 2012. "Exit from a Monetary Union through Euroization: Discipline without Chaos," NBER Working Papers 17908, National Bureau of Economic Research, Inc.

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