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

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  • Beetsma, Roel
  • Vermeylen, Koen

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 this debt increases. Also, the share of the debt issued by relatively short-sighted governments, or by countries that initially have a relatively dependent central bank, increases after unification. A transfer scheme that penalizes debt increases beyond the union average is able to undo the interest rate effect of unification, but further magnifies the spread of the relative debt levels.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3491.

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Date of creation: Aug 2002
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Handle: RePEc:cpr:ceprdp:3491

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

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Cited by:
  1. Jérôme Creel & Jacques Le Cacheux, 2003. "Inflation Divergence and Public Deficits In an Monetary Union," Sciences Po publications N° 2003-05, Sciences Po.
  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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