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Inflation divergence and public deficits in a monetary union

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We reconsider the link between domestic public debts and average and domestic inflation rates in a monetary union, using a modified version of a model by Beetsma and Vermeylen (2002). It is thus possible to show that the causation between the inflation dynamics and the public finances might go from the former to the latter. We are thus able to tackle the issue of persistently divergent inflation rates within the euro area. We also demonstrate that the homogeneous fiscal rules defined in the Stability and Growth Pact are ill-suited and might even be counterproductive. This conclusion is all the more true as the EU is on the eve of enlargement towards the CEECs: our results show that imposing homogeneous fiscal rules to the CEECs may prove disruptive.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2003-05.

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Date of creation: 2003
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Handle: RePEc:fce:doctra:0305

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Keywords: inflation; public debt; monetary union; fiscal rule;

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  1. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  2. Willem H. Buiter & Clemens Grafe, 2004. "Patching up the Pact," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 12(1), pages 67-102, 03.
  3. Roel Beetsma & Koen Vermeylen, 2007. "The effect of monetary unification on public debt and its real return," Public Choice, Springer, vol. 133(3), pages 393-415, December.
  4. Fidrmuc, Jarko & Korhonen, Iikka, 2001. "Similarity of supply and demand shocks between the Euro area and the CEECs," BOFIT Discussion Papers 14/2001, Bank of Finland, Institute for Economies in Transition.
  5. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  6. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  7. Tamim Bayoumi and Barry Eichengreen., 1992. "Shocking Aspects of European Monetary Unification," Economics Working Papers 92-187, University of California at Berkeley.
  8. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  9. Jacky Fayolle & Guilhem Bentoglio & Matthieu Lemoine, 2002. "Unity and Plurality of the European Cycle," Sciences Po publications N°2002-3, Sciences Po.
  10. Willem H. Buiter, 2002. "The Fiscal Theory Of The Price Level: A Critique," Economic Journal, Royal Economic Society, vol. 112(481), pages 459-480, July.
  11. Coricelli, Fabrizio & Ercolani, Valerio, 2002. "Cyclical and Structural Deficits on the Road to Accession: Fiscal Rules for an Enlarged European Union," CEPR Discussion Papers 3672, C.E.P.R. Discussion Papers.
  12. Babetskii, Ian & Boone, Laurence & Maurel, Mathilde, 2002. "Exchange Rate Regimes and Supply Shocks Asymmetry: The Case of the Accession Countries," CEPR Discussion Papers 3408, C.E.P.R. Discussion Papers.
  13. Babetskii, Ian & Boone, Laurence & Maurel, Mathilde, 2004. "Exchange rate regimes and shocks asymmetry: the case of the accession countries," Journal of Comparative Economics, Elsevier, vol. 32(2), pages 212-229, June.
  14. D. Mario Nuti, 2002. "Costs and benefits of unilateral euroization in central eastern Europe," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 10(2), pages 419-444, July.
  15. Jérôme Creel & Henri Sterdyniak, 2000. "La théorie budgétaire du niveau des prix, un bilan critique," Sciences Po publications 2000-03, Sciences Po.
  16. Bergin, Paul R., 2000. "Fiscal solvency and price level determination in a monetary union," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 37-53, February.
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