Regional Debt in Monetary Unions: Is it Inflationary?

35 Pages Posted: 8 Oct 2010

See all articles by Russell Cooper

Russell Cooper

University of Texas at Austin - Department of Economics; National Bureau of Economic Research (NBER)

Hubert Kempf

Ecole Normale Superieure de Cachan (ENS)

Dan Peled

University of Haifa - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: November 1, 2007

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 no 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.

Keywords: Monetary Union, Inflation Tax, Seigniorage, Public Debt

JEL Classification: E31, E42, E58, E62

Suggested Citation

Cooper, Russell W. and Kempf, Hubert and Peled, Dan, Regional Debt in Monetary Unions: Is it Inflationary? (November 1, 2007). Banque de France Working Paper No. NER - R 186. Available at SSRN: https://ssrn.com/abstract=1689002 or http://dx.doi.org/10.2139/ssrn.1689002

Russell W. Cooper (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hubert Kempf

Ecole Normale Superieure de Cachan (ENS) ( email )

61 avenue du président Wilson
Cachan, Paris 94235
France

Dan Peled

University of Haifa - Department of Economics ( email )

Haifa 31905
Israel

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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