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Regional Debt in Monetary Unions: Is it Inflationary ?

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  • Russell Cooper

    () (University of Texas - Department of Economics)

  • Hubert Kempf

    () (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, Banque de France - Direction de la Recherche)

  • Dan Peled

    () (University of Haifa - Department of Economics)

Abstract

This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with non inflationary consequences ? Or will the circulation of region debt induce monetization by a central bank ? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of the holdings of the regional debt. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of policy measures within a monetary union.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00344475.

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Date of creation: Nov 2008
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Handle: RePEc:hal:cesptp:halshs-00344475

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Keywords: Monetary union ; inflation tax ; seigniorage ; public debt;

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  1. Beetsma, Roel & Uhlig, Harald, 1999. "An Analysis of the Stability and Growth Pact," Economic Journal, Royal Economic Society, vol. 109(458), pages 546-71, October.
  2. Fernando Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," NBER Working Papers 12783, National Bureau of Economic Research, Inc.
  3. Varadarajan V. Chari & Patrick J. Kehoe, 2008. "Time Inconsistency and Free-Riding in a Monetary Union," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1329-1356, October.
  4. Russell Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report 311, Federal Reserve Bank of Minneapolis.
  5. 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.
  6. Russell Cooper & Hubert Kempf & Dan Peled, 2008. "Is It Is Or Is It Ain'T My Obligation? Regional Debt In A Fiscal Federation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(4), pages 1469-1504, November.
  7. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  8. Chari, V.V. & Kehoe, Patrick J., 2007. "On the need for fiscal constraints in a monetary union," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2399-2408, November.
  9. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
  10. Russell W. Cooper & Hubert Kempf., 2001. "Dollarization and the conquest of hyperinflation in divided societies," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-12.
  11. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
  12. Beetsma, Roel M.W.J. & Debrun, Xavier, 2007. "The new stability and growth pact: A first assessment," European Economic Review, Elsevier, vol. 51(2), pages 453-477, February.
  13. Carlos E. Zarazaga, 1993. "Hyperinflations and moral hazard in the appropriation of seigniorage," Working Papers 93-26, Federal Reserve Bank of Philadelphia.
  14. Dixit, Avinash & Lambertini, Luisa, 2003. "Symbiosis of monetary and fiscal policies in a monetary union," Journal of International Economics, Elsevier, vol. 60(2), pages 235-247, August.
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Cited by:
  1. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
  2. Russell Cooper & Hubert Kempf & Dan Peled, 2009. "Insulation impossible: fiscal spillovers in a monetary union," Globalization and Monetary Policy Institute Working Paper 30, Federal Reserve Bank of Dallas.
  3. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.

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