Coordination and Crisis in Monetary Unions

By Mark Aguiar, Manuel Amador, Emmanuel Farhi, Gita Gopinath. 2015

126 citations recorded by the source corpus.

We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to overborrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises. JEL Codes: E4, E5, F3, F4.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/70feb412aff3b512a9a1e9461fc3a19d27b7b238