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

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

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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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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  18. Weil, Philippe, 1991. "Is Money Net Wealth?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(1), pages 37-53, February.
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