Inflationary Consequences of the Indebtedness Levels of the Member Countries in a Monetary Union

Séverine Menguy ()
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Séverine Menguy: Département des Sciences Sociales, Université Paris Descartes, Paris – France

The Journal of European Theoretical and Applied Studies, 2013, vol. 1, issue 1, 87-111

Abstract: This paper studies the impact on the common monetary policy and the externalities due to various levels of indebtedness of the member countries in a monetary union. While the common central bank conducts a more accommodative monetary policy in order to avoid default of moderately indebted member countries, the most heavily indebted countries have to default. More precisely, the optimal inflation rate increases as the weight given by the central bank to price stability gets smaller, as the number of highly indebted countries in the union grows, and as the share of nominal debt from these countries in the global indebtedness of the monetary union gets higher. Moreover, inflation increases as the interest rate on the risk free capital gets higher and as the interest rate on inflation indexed bonds in fiscally weak countries is reduced. Finally, inflation increases as the incentive effect on the issuing of public debt at a smaller default cost decreases, and then becomes an increasing function of this cost of default in fiscally weak countries.

Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:kir:journl:v:1:y:2013:i:1:p:87-111

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