Coordination and crisis in monetary unions

Mark Aguiar, Manuel Amador, Emmanuel Farhi, Gita Gopinath

Research output: Contribution to journalArticlepeer-review

19 Scopus citations

Abstract

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.

Original languageEnglish (US)
Article numberqjv022
Pages (from-to)1727-1779
Number of pages53
JournalQuarterly Journal of Economics
Volume130
Issue number4
DOIs
StatePublished - Nov 2015

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Fingerprint Dive into the research topics of 'Coordination and crisis in monetary unions'. Together they form a unique fingerprint.

Cite this