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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

    ()
    (Paris School of Economics - Centre d'Economie de la Sorbonne)

  • 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 Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne in its series Documents de travail du Centre d'Economie de la Sorbonne with number v08070.

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Length: 27 pages
Date of creation: Dec 2008
Date of revision:
Handle: RePEc:mse:cesdoc:v08070

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Keywords: Monetary union; inflation tax; Seigniorage; public debt.;

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  1. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  2. Fernando A Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," Working Papers 306, Barcelona Graduate School of Economics.
  3. Russell Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report 311, Federal Reserve Bank of Minneapolis.
  4. 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.
  5. 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.
  6. V. V. Chari & Patrick J. Kehoe, 2008. "Time inconsistency and free-riding in a monetary union," Staff Report 308, Federal Reserve Bank of Minneapolis.
  7. 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.
  8. Aizenman, Joshua, 1992. "Competitive Externalities and the Optimal Seigniorage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 61-71, February.
  9. 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.
  10. 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.
  11. 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.
  12. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
  13. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
  14. Carlos E. Zarazaga, 1993. "Hyperinflations and moral hazard in the appropriation of seigniorage," Working Papers 93-26, Federal Reserve Bank of Philadelphia.
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Citations

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Cited by:
  1. Sokolova, A., 2014. "Sovereign Risk and Monetary Policy," Journal of the New Economic Association, New Economic Association, vol. 21(1), pages 56-82.
  2. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2014. "Coordination and Crisis in Monetary Unions," NBER Working Papers 20277, National Bureau of Economic Research, Inc.
  3. Russell Cooper & Hubert Kempf & Dan Peled, 2010. "Insulation Impossible : Fiscal Spillovers in a Monetary Union," Documents de travail du Centre d'Economie de la Sorbonne 10045, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  4. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
  5. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
  6. Russell Cooper, 2012. "Exit from a Monetary Union through Euroization: Discipline without Chaos," NBER Working Papers 17908, National Bureau of Economic Research, Inc.
  7. Anna Sokolova, 2013. "Fiscal Limits and Monetary Policy: Default vs. Inflation," HSE Working papers WP BRP 39/EC/2013, National Research University Higher School of Economics.
  8. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.

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