Coordination and Crisis in Monetary Unions / Mark Aguiar, Manuel Amador, Emmanuel Farhi, Gita Gopinath.

Format:

Book

Author/Creator:

Aguiar, Mark.

Contributor:

National Bureau of Economic Research.

Amador, Manuel.

Farhi, Emmanuel.

Gopinath, Gita.

Series:

Working Paper Series (National Bureau of Economic Research) no. w20277.

NBER working paper series no. w20277

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2014.

Summary:

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.

Notes:

Print version record

July 2014.