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How relieving is public debt relief? Monetary and fiscal policies in a monetary union during a debt crisis

Dmitri Blueschke (), Reinhard Neck and A. Wittmann ()
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A. Wittmann: University of Klagenfurt

Central European Journal of Operations Research, 2020, vol. 28, issue 2, No 10, 539-559

Abstract: Abstract We use a dynamic game model of a two-country monetary union to study the consequences of sovereign debt reliefs for a member country or bloc of countries of the union after an exogenous fall in aggregate demand and the resulting increase in public debt. The debt reliefs are assumed to occur endogenously, being enacted after an increase of government debt beyond a certain threshold. We assume that the governments of the countries participating in the union pursue national goals when deciding on fiscal policies whereas the common central bank’s monetary policy aims at union-wide objective variables. The union considered is asymmetric, consisting of a “core” with lower initial public debt, and a “periphery” with higher initial public debt. The “periphery” may experience debt reliefs due to the high level of its sovereign debt. We calculate numerical solutions of the dynamic game between the governments and the central bank using the OPTGAME algorithm. We show that a debt relief as modeled in our study is disadvantageous for both the “core” and the “periphery” of the monetary union, and that after an initial haircut further debt reliefs will be required to an extent that threatens the existence of the entire union.

Keywords: Dynamic game; Numerical solutions; Feedback Nash equilibrium; Pareto solution; Economic dynamics; Monetary union; Macroeconomics; Public debt (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s10100-020-00677-7

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