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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. Bohn, Henning, 1991. "Time consistency of monetary policy in the open economy," Journal of International Economics, Elsevier, vol. 30(3-4), pages 249-266, May.
  2. Alessandro Missale & Olivier Jean Blanchard, 1991. "The Debt Burden and Debt Maturity," NBER Working Papers 3944, National Bureau of Economic Research, Inc.
  3. 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,.
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  5. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  6. Jeromin Zettelmeyer, 1996. "EMU and Long Interest Rates in Germany," IMF Working Papers 96/133, International Monetary Fund.
  7. Harry P. Huizinga & Jan J.G. Lemmen & Sylvester C.W. Eijffinger, 1997. "Short-Term and Long-Term Government Debt and Nonresident Interest Withholding Taxes," FMG Discussion Papers dp275, Financial Markets Group.
  8. Bovenberg, A.L. & Beetsma, R.M.W.J., 1997. "Central Bank independence and public debt policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-74443, Tilburg University.
  9. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "The interaction of fiscal and monetary policy in a monetary union: Balancing credibility and flexibility," Discussion Paper 1995-101, Tilburg University, Center for Economic Research.
  10. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
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  12. Bohn, Henning, 1990. "A positive theory of foreign currency debt," Journal of International Economics, Elsevier, vol. 29(3-4), pages 273-292, November.
  13. Martin Feldstein & Philippe Bacchetta, 1989. "National Saving and International Investment," NBER Working Papers 3164, National Bureau of Economic Research, Inc.
  14. International Monetary Fund, 1995. "The Role of Foreign Currency Debt in Public Debt Management," IMF Working Papers 95/21, International Monetary Fund.
  15. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
  16. Alberto Giovannini, 1996. "The Debate on Money in Europe," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071681, December.
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Cited by:
  1. Beetsma, Roel & Uhlig, Harald, 1997. "An Analysis of the 'Stability Pact'," CEPR Discussion Papers 1669, C.E.P.R. Discussion Papers.
  2. Fidrmuc, Jan & Horvath, Julius & Fidrmuc, Jarko, 1999. "Stability of Monetary Unions: Lessons from the Break-up of Czechoslovakia," Transition Economics Series 10, Institute for Advanced Studies.

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