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Sovereign Risk In The Euro Zone And Monetary Policy

Author

Listed:
  • EIJI OKANO

    (Faculty of Economics, Chiba Keizai University, 59-5, Todorokicho 3-Chome, Inage-ku, Chiba-shi, Chiba, 263-0021, Japan)

  • EIJI OGAWA

    (Graduate School of Commerce and Management, Hitotsubashi University, 186-8601 Tokyo, Japan)

Abstract

We analyze monetary policy in a currency union with sovereign risk by using a three-country model including a two-country currency union and introduce anad hocassumption that one of the two countries is exposed to sovereign risk. In our model, if expected fiscal revenue is less than current public debt, one country can default whereas the other country cannot default. In a canonical setting that analyzes optimal monetary policy, the optimal monetary policy is consistent with the Taylor rule. However, the Taylor rule is not optimal and persistently causes defaults in our model. In contrast, an interest rate peg, namely government bonds swaps, terminates defaults after one period and is optimal in our model.

Suggested Citation

  • Eiji Okano & Eiji Ogawa, 2012. "Sovereign Risk In The Euro Zone And Monetary Policy," Global Journal of Economics (GJE), World Scientific Publishing Co. Pte. Ltd., vol. 1(02), pages 1-30.
    • Handle: RePEc:wsi:gjexxx:v:01:y:2012:i:02:n:s2251361212500115
    DOI: 10.1142/S2251361212500115
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    References listed on IDEAS

    as
    1. Stephanie Schmitt-Grohe & Jess Benhabib & Martin Uribe, 2001. "Monetary Policy and Multiple Equilibria," American Economic Review, American Economic Association, vol. 91(1), pages 167-186, March.
    2. Beetsma, Roel M.W.J. & Jensen, Henrik, 2005. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Journal of International Economics, Elsevier, vol. 67(2), pages 320-352, December.
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    More about this item

    Keywords

    Sovereign risk; European crisis; fixed-interest-rate rule; fiscal theory of price level; E52; E60; F41; F47;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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