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A graceful return of the drachma

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  • Daniel, Betty C.

Abstract

A country participating in a monetary union is constrained by loss of control over seigniorage revenue. Once the government reaches its fiscal limit on ordinary taxation, it cannot turn to seigniorage for financing. We show that a monetary union country can increase its seigniorage revenue by reissuing its own currency even as it fully honors all outstanding debt obligations. We use a simple cash-in-advance model, with domestic currency demand motivated by the need to pay taxes, to show that this policy effectively redistributes seigniorage revenue away from other monetary union members toward the acting country. The magnitude of the seigniorage created by currency reissue is limited both by the relative size of the country and by money demand, and, therefore, by the tax base. If this seigniorage revenue is insufficient, some additional seigniorage is available by allowing the new currency to grow and depreciate over time and domestic real wages to fall.

Suggested Citation

  • Daniel, Betty C., 2014. "A graceful return of the drachma," European Economic Review, Elsevier, vol. 71(C), pages 228-243.
  • Handle: RePEc:eee:eecrev:v:71:y:2014:i:c:p:228-243
    DOI: 10.1016/j.euroecorev.2014.08.004
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    References listed on IDEAS

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    1. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
    2. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
    3. Charles Engel & John H. Rogers, 2006. "The U.S. current account deficit and the expected share of world output," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    4. Davig, Troy & Leeper, Eric M. & Walker, Todd B., 2011. "Inflation and the fiscal limit," European Economic Review, Elsevier, vol. 55(1), pages 31-47, January.
    5. 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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    Cited by:

    1. Pierre ALDAMA & Jérôme Creel, 2017. "Fiscal policy in the US : Ricardian after all ?," Documents de Travail de l'OFCE 2017-23, Observatoire Francais des Conjonctures Economiques (OFCE).
    2. Betty Daniel, Christos Shiamptanis, 2015. "Predicting Sovereign Fiscal Crises: High-Debt Developed Countries," LCERPA Working Papers 0090, Laurier Centre for Economic Research and Policy Analysis, revised 05 May 2015.

    More about this item

    Keywords

    F41; F42; Monetary union; Seigniorage; Dual currency; Fiscal limits;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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