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On prosperity and posterity: the need for fiscal discipline in a monetary union

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  • Detken, Carsten
  • Gaspar, Vítor
  • Winkler, Bernhard

Abstract

We show how in a Blanchard-Yaari, overlapping generations framework, perfect substitutability of government bonds in Monetary Union tempts governments to exploit the enlarged common pool of savings. In Nash equilibrium all governments increase their bond financed transfers to current generations (prosperity effect) at the expense of future generations (posterity effect). The resulting deficit bias occurs even if one assumes that before Monetary Union countries had eliminated their deficit bias by designing appropriate domestic institutions. The paper provides a rationale for an increased focus on fiscal discipline in Monetary Union, without the need to assume imperfect credibility of existing Treaty provisions or to refer to extreme situations involving sovereign default. We draw on existing empirical evidence to argue that the degree of government bond substitutability within the European Monetary Union is an order of magnitude larger than in the global economy. JEL Classification: D62, E61, E63

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0420.

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Date of creation: Dec 2004
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Handle: RePEc:ecb:ecbwps:20040420

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Keywords: bond market integration; common pool; European Monetary Union; fiscal discipline; fiscal rules; fiscal spillover effects; overlapping generations;

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Citations

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Cited by:
  1. António Afonso, 2007. "Public finances in Portugal: a brief longrun view," Working Papers Department of Economics 2007/01, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  2. repec:spo:wpecon:info:hdl:2441/1482 is not listed on IDEAS
  3. Benczes, Istvan, 2011. "Rules-based economic governance in the European Union: A reappraisal of national fiscal rules," MPRA Paper 34912, University Library of Munich, Germany.
  4. Jean-Paul Fitoussi & Francesco Saraceno, 2008. "Fiscal Discipline as a Social Norm: The European Stability Pact," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(6), pages 1143-1168, December.
  5. Philipp Paulus, 2006. "Brüssel, Frankfurt oder Basel - Wo muss das Problem steigender Staatsschulden in der Europäischen Währungsunion gelöst werden?," Otto-Wolff-Institut Discussion Paper Series 01/2006, Otto-Wolff-Institut für Wirtschaftsordnung, Köln, Deutschland.
  6. Otmar Issing, 2006. "Europe’s hard fix: the Euro area," International Economics and Economic Policy, Springer, vol. 3(3), pages 181-196, December.

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