Coordination and Crisis in Monetary Unions

Mark Aguiar, Manuel Amador, Emmanuel Farhi and Gita Gopinath

The Quarterly Journal of Economics, 2015, vol. 130, issue 4, 1727-1779

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. JEL Codes: E4, E5, F3, F4.

Date: 2015
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Related works:
Working Paper: Coordination and Crisis in Monetary Unions (2015)
Working Paper: Coordination and Crisis in Monetary Unions (2015)
Working Paper: Coordination and Crisis in Monetary Unions (2014)
Working Paper: Coordination and Crisis in Monetary Unions
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