IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Fiscal Risk in a Monetary Union

  • Betty Daniel
  • Christos Shiamptanis

A country entering a monetary union gives up the right to determine its own monetary policy. Individual fiscal authorities promise passive fiscal policy, allowing the central monetary authority to use active monetary policy. Since a government, which can print its own money, can honor its nominal debt unconditionally, entrance into a monetary union raises new issues of potential fiscal insolvency. When there is an upper bound on the magnitude of the surplus and stochastic shocks to the surplus, a government can find itself in a position in which it cannot borrow to continue with its desired passive fiscal policy. This paper considers the risk of a fiscal financial crisis in a monetary union under alternative assumptions about how the fiscal authority would respond. The response affects the timing and probability of a crisis. We consider both outright default and policy switching, whereby the fiscal authority in crisis switches to active fiscal policy and the monetary authority switches to passive monetary policy. We apply the model to estimate fiscal risk in the European Monetary Union. Using panel estimates of the parameters in the surplus rule and initial values for government debt and the primary surplus, we simulate fiscal risk under the two alternative fiscal responses to a crisis. We find that countries with initial values bound by the Maastricht Treaty limits are safe, while countries like Italy and Greece, in which debt has strayed far above these limits, might not be.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.albany.edu/economics/research/workingp/2008/RiskEMU12188.pdf
Download Restriction: no

Paper provided by University at Albany, SUNY, Department of Economics in its series Discussion Papers with number 08-12.

as
in new window

Length:
Date of creation: 2008
Date of revision:
Handle: RePEc:nya:albaec:08-12
Contact details of provider: Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
Phone: (518) 442-4735
Fax: (518) 442-4736

Order Information: Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
Web: http://www.albany.edu/economics/research/workingp/index.shtml Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Troy Davig & Eric M. Leeper & Hess Chung, 2004. "Monetary and Fiscal Policy Switching," NBER Working Papers 10362, National Bureau of Economic Research, Inc.
  2. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Staff Report 147, Federal Reserve Bank of Minneapolis.
  3. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  4. 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.
  5. Martin Uribe, 2002. "A Fiscal Theory of Sovereign Risk," NBER Working Papers 9221, National Bureau of Economic Research, Inc.
  6. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," NBER Working Papers 5131, National Bureau of Economic Research, Inc.
  7. Russell Cooper & Hubert Kempf & Dan Peled, 2008. "Regional debt in monetary unions : is it inflationary ?," Documents de travail du Centre d'Economie de la Sorbonne v08070, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  8. Campbell leith & Simon Wren-Lewis, . "Compatibility Between Monetary and Fiscal Policy Under EMU," Working Papers 2001_15, Business School - Economics, University of Glasgow.
  9. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
  10. Márcio Gomes Pinto Garcia & Roberto Rigobon, 2004. "A Risk Management Approach to Emerging Market’s Sovereign Debt Sustainability with an Application to Brazilian Data," Textos para discussão 484, Department of Economics PUC-Rio (Brazil).
  11. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," CEPR Discussion Papers 1772, C.E.P.R. Discussion Papers.
  12. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  13. Troy Davig & Eric M. Leeper & Todd B. Walker, 2010. "Inflation and the Fiscal Limit," NBER Working Papers 16495, National Bureau of Economic Research, Inc.
  14. Cochrane, John H., 2005. "Money as stock," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 501-528, April.
  15. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," CRSP working papers 479, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  16. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
  17. repec:hal:journl:halshs-00344475 is not listed on IDEAS
  18. Woodford, Michael, 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Seminar Papers 632, Stockholm University, Institute for International Economic Studies.
  19. Michael Kumhof, 2004. "Fiscal Crisis Resolution: Taxation Versus Inflation," 2004 Meeting Papers 874, Society for Economic Dynamics.
  20. Betty C. Daniel & Christos Shiamptanis, 2009. "Fiscal Policy in the European Monetary Union," Working Papers 2009-1, Central Bank of Cyprus.
  21. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  22. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  23. Schabert, Andreas, 2010. "Monetary policy under a fiscal theory of sovereign default," Journal of Economic Theory, Elsevier, vol. 145(2), pages 860-868, March.
  24. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," NBER Working Papers 6771, National Bureau of Economic Research, Inc.
  25. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the fiscal theory of the price level," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-38.
  26. Betty Daniel, 2000. "A Fiscal Theory of Currency Crises," Econometric Society World Congress 2000 Contributed Papers 0535, Econometric Society.
  27. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  28. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
  29. Betty C. Daniel, 2010. "Exchange Rate Crises and Fiscal Solvency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1109-1135, 09.
  30. Troy Davig & Eric M. Leeper, 2011. "Temporarily Unstable Government Debt and Inflation," NBER Working Papers 16799, National Bureau of Economic Research, Inc.
  31. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  32. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  33. 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.
  34. Troy Davig & Eric M. Leeper & Todd B. Walker, 2010. ""Unfunded Liabilities" and Uncertain Fiscal Financing," NBER Working Papers 15782, National Bureau of Economic Research, Inc.
  35. Narayana Kocherlakota & Christopher Phelan, 1999. "Explaining the fiscal theory of the price level," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-23.
  36. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  37. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  38. Daniel, Betty C., 2001. "The fiscal theory of the price level in an open economy," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 293-308, October.
  39. Evan Tanner & Issouf Samaké, 2006. "Probabilistic Sustainability of Public Debt; A Vector Autoregression Approach for Brazil, Mexico, and Turkey," IMF Working Papers 06/295, International Monetary Fund.
  40. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
  41. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:nya:albaec:08-12. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (John Bailey Jones)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.