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Interest-Rate Spread and Public-Debt Dynamics in a Two-Country Monetary-Union Portfolio Model

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  • Roberto Tamborini

Abstract

Tracking, monitoring and steering the evolution of public debt over time will be a major policy challenge for almost all governments in the advanced countries in the years to come, in particular for those belonging to the European Monetary Union. In this paper I study public debt dynamics in a two-country monetary union where a representative, risk-averse wealth-owner optimizes his/her portfolio of sovereign bonds issued in the common currency. I obtain two main results with respect to the standard country-by-country approach. First, the interest-rate spread between the two countries is endogenized as the higher-debt country pays a risk premium which is proportional to the level of its own debt with respect to the debt of the other. Second, its debt dynamic path becomes nonlinear and dependent on the evolution of the other country’s debt. The most important policy implication is that “dynamic interdependence” is not fully considered in the implementation of EMU fiscal rules, but it may may jeopardize their goal of convergence and stability of debt stocks. Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Roberto Tamborini, 2014. "Interest-Rate Spread and Public-Debt Dynamics in a Two-Country Monetary-Union Portfolio Model," Open Economies Review, Springer, vol. 25(2), pages 243-261, April.
    • Handle: RePEc:kap:openec:v:25:y:2014:i:2:p:243-261
    DOI: 10.1007/s11079-013-9279-3
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    Cited by:

    1. Jussi Lindgren, 2021. "Examination of Interest-Growth Differentials and the Risk of Sovereign Insolvency," Risks, MDPI, vol. 9(4), pages 1-14, April.
    2. Roberto Tamborini, 2017. "Europe at the Interdependence War," EconPol Working Paper 2, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    3. Pompeo Della Posta & Roberto Tamborini, 2022. "The existential trilemma of EMU in a model of fiscal target zone," Oxford Open Economics, Oxford University Press, vol. 1, pages 1-16.
    4. Roberto Tamborini, 2013. "The new fiscal rules for the EMU. Threats from heterogeneity and interdependence," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 10(3), pages 415-436, December.
    5. António Afonso & Frederico Silva Leal, 2017. "Sovereign yield spreads in the EMU: crisis and structural determinants," Working Papers Department of Economics 2017/09, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.

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    More about this item

    Keywords

    European Monetary Union; Public debt dynamics; Portfolio models of public debt; F3; H6;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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