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Long Term Debt and the Political Support of a Monetary Union

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  • Uhlig, Harald

Abstract

This paper examines the role of long-term debt in political support for a monetary union or, more generally, an inflation-reduction policy. The central idea is that the decision on membership of the union leads to a redistribution between debtors and creditors, if they are holding long-term debt with a nominally fixed interest rate, as well as taxpayers. For example, if joining the union means a decrease in the inflation rate, creditors should favour joining while debtors should be against it. A government of a high-inflation country might strategically try to exploit this effect by selling more long-term debt denominated in its own currency at a fixed nominal rate rather than a foreign currency such as the dollar (or, almost equivalently, as floating-rate debt or rolled-over short-term debt) to its citizens. We show that the effect on political support is unclear. While the ‘creditor effect’ of increasing the number of agents holding domestically denominated debt helps generate support for joining the union, the ‘tax effect’ of having to raise more taxes in order to pay for the increased real-debt payments after a successful monetary union works in the opposite way. The paper then studies a number of special cases and ramifications; the case of Italy is examined more closely. The paper argues that recent debt-management policy in Italy probably eroded political support for actions aimed at enhancing EMU membership chances.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1603.

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Date of creation: Mar 1997
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Handle: RePEc:cpr:ceprdp:1603

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Keywords: Debt Management; EMU; Monetary Policy; Political Economy; Redistribution;

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References

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  1. Eijffinger, S-C-W & de Haan, J, 1996. "The Political Economy of Central-Bank Independence," Princeton Studies in International Economics 19, International Economics Section, Departement of Economics Princeton University,.
  2. Eijffinger, S.C.W. & Huizinga, H.P. & Lemmen, J.J.G., 1998. "Short-term and long-term government debt and non resident interest witholding taxes," Open Access publications from Tilburg University urn:nbn:nl:ui:12-76575, Tilburg University.
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  11. International Monetary Fund, 1995. "The Role of Foreign Currency Debt in Public Debt Management," IMF Working Papers 95/21, International Monetary Fund.
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  14. Milesi-Ferretti, Gian Maria, 1995. "The Disadvantage of Tying Their Hands: On the Political Economy of Policy Commitments," Economic Journal, Royal Economic Society, vol. 105(433), pages 1381-1402, November.
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  17. Jeromin Zettelmeyer, 1996. "EMU and Long Interest Rates in Germany," IMF Working Papers 96/133, International Monetary Fund.
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Citations

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Cited by:
  1. Fidrmuc, Jan & Horvath, Julius & Fidrmuc, Jarko, 1999. "Stability of monetary unions: Lessons from the break-up of Czechoslovakia," ZEI Working Papers B 17-1999, ZEI - Center for European Integration Studies, University of Bonn.
  2. Beetsma, Roel & Uhlig, Harald, 1997. "An Analysis of the 'Stability Pact'," CEPR Discussion Papers 1669, C.E.P.R. Discussion Papers.

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