On Prosperity and Posterity: The Need for Fiscal Discipline in a Monetary Union

42 Pages Posted: 20 Dec 2004

See all articles by Carsten Detken

Carsten Detken

European Central Bank (ECB)

Vitor Gaspar

European Commission

Bernhard Winkler

European Central Bank (ECB)

Date Written: December 2004

Abstract

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.

Keywords: fiscal spillover effects, common pool, overlapping generations, bond market integration, fiscal discipline, fiscal rules, European Monetary Union

JEL Classification: D62, E61, E63

Suggested Citation

Detken, Carsten and Gaspar, Vitor and Winkler, Bernhard, On Prosperity and Posterity: The Need for Fiscal Discipline in a Monetary Union (December 2004). Available at SSRN: https://ssrn.com/abstract=617813

Carsten Detken (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

Vitor Gaspar

European Commission ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7200 (Phone)
+49 69 1344 6575 (Fax)

Bernhard Winkler

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

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