Coordination and Crisis in Monetary Unions

44 Pages Posted: 24 Jul 2014

See all articles by Mark Aguiar

Mark Aguiar

Princeton University

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Emmanuel Farhi

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

Gita Gopinath

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

Date Written: July 2014

Abstract

We characterize 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 over borrow; 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.

Suggested Citation

Aguiar, Mark and Amador, Manuel and Farhi, Emmanuel and Gopinath, Gita, Coordination and Crisis in Monetary Unions (July 2014). NBER Working Paper No. w20277, Available at SSRN: https://ssrn.com/abstract=2471170

Mark Aguiar (Contact Author)

Princeton University ( email )

Princeton, NJ 08544-1021
United States

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Emmanuel Farhi

Harvard University - Department of Economics ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Gita Gopinath

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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