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Long Term Debt and the Political Support for a Monetary Union

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  • Uhlig, H.F.H.V.S.

    (Tilburg University, Center for Economic Research)

Abstract

This paper examines the role of long term debt for the political support of a monetary union or, more generally, an inflation-reduction policy. The central idea is that the decision about membership in 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 tax payers. For example, if joining the union means a decrease in the inflation rate, creditors should favor 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 generating 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 is probable to have eroded the political support for actions aimed at enhancing EMU membership chances

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 1997-13.

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Date of creation: 1997
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Handle: RePEc:dgr:kubcen:199713

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Keywords: monetary integration; national debt; monetary policy; inflation;

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References

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  1. Eijffinger, S.C.W. & Huizinga, H.P. & Lemmen, J.J.G., 1996. "Short-Term and Long-Term Government Debt and Nonresident Interest Withholding Taxes," Discussion Paper 1996-88, Tilburg University, Center for Economic Research.
  2. 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.
  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,.
  4. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "The Interaction of Fiscal and Monetary Policy in a Monetary Union: Balancing Credibility and Flexibility," DELTA Working Papers 95-24, DELTA (Ecole normale supérieure).
  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. Bohn, Henning, 1990. "A positive theory of foreign currency debt," Journal of International Economics, Elsevier, vol. 29(3-4), pages 273-292, November.
  7. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
  8. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
  9. 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.
  10. G Milesi-Feretti, 1991. "Do Good or Do Well? Public Debt Management in a Two-Party Economy," CEP Discussion Papers dp0053, Centre for Economic Performance, LSE.
  11. Martin Feldstein & Philippe Bacchetta, 1991. "National Saving and International Investment," NBER Chapters, in: National Saving and Economic Performance, pages 201-226 National Bureau of Economic Research, Inc.
  12. International Monetary Fund, 1995. "The Role of Foreign Currency Debt in Public Debt Management," IMF Working Papers 95/21, International Monetary Fund.
  13. Beetsma, Roel M. W. J. & Bovenberg, A. Lans, 1997. "Central bank independence and public debt policy," Journal of Economic Dynamics and Control, Elsevier, vol. 21(4-5), pages 873-894, May.
  14. Jeromin Zettelmeyer, 1996. "EMU and Long Interest Rates in Germany," IMF Working Papers 96/133, International Monetary Fund.
  15. Alberto Giovannini, 1996. "The Debate on Money in Europe," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071681, December.
  16. Alessandro Missale & Olivier Jean Blanchard, 1991. "The Debt Burden and Debt Maturity," NBER Working Papers 3944, National Bureau of Economic Research, Inc.
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Cited by:
  1. Uhlig, H.F.H.V.S. & Beetsma, R.M.W.J., 1997. "An Analysis of the Stability Pact," Discussion Paper 1997-59, Tilburg University, Center for Economic Research.
  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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