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The Effect of Monetary Unification on Public Debt and its Real Return

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  • Roel Beetsma
  • Koen Vermeylen

Abstract

We explore the implications of monetary unification for real interest rates and (relative) public debt levels. The adoption of a common monetary policy renders the risk-return characteristics of the participating countries more similar, so that the substitutability of their public debt increases after unification. This implies that the average expected real return on the debt increases. Also, the share of the unionwide debt issued by relatively myopic governments or of countries that initially have a relatively dependent central bank increases after unification. This may put the political sustainability of the union under pressure. A transfer scheme that penalizes debt increases beyond the union average is able to undo the interest rate effect of unification, but magnifies the spread in relative debt levels.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2005/wp-cesifo-2005-02/cesifo1_wp1400.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1400.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1400

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Keywords: monetary union; (relative) public debt; interest rates; externalities; substitutability; central bank independence;

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Cited by:
  1. Jerome Creel & Jacques Le Cacheux, 2003. "Inflation divergence and public deficits in a monetary union," Documents de Travail de l'OFCE 2003-05, Observatoire Francais des Conjonctures Economiques (OFCE).
  2. Eichler, Stefan, 2012. "Financial crisis risk, ECB “non-standard” measures, and the external value of the euro," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(3), pages 257-265.

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