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Regional Debt in Monetary Unions: Is it Inflationary ?

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Author Info
Russell Cooper () (University of Texas - Department of Economics)
Hubert Kempf () (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, Banque de France - Direction de la Recherche)
Dan Peled () (University of Haifa - Department of Economics)

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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 non 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.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00344475_v1.

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Date of creation: Nov 2008
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Handle: RePEc:hal:cesptp:halshs-00344475_v1

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Keywords: Monetary union ; inflation tax ; seigniorage ; public debt;

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