Abstract
We explore the implications of monetary unification for real interest rates and (relative) public debt levels. The adoption of a common monetary policy renders the risk-return characteristics of the participating countries’ public debt more similar. The implied reduction in the scope for risk diversification raises the average expected real return on the debt. Also, the share of the union-wide debt issued by relatively myopic governments or of countries that initially have a relatively dependent central bank increases after unification. This may put the political sustainability of the union under pressure. A transfer scheme that penalizes debt increases beyond the union average is able to undo the interest rate effect of unification, but magnifies the spread in relative debt levels.
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Beetsma, R.M.W.J., Vermeylen, K. The effect of monetary unification on public debt and its real return. Public Choice 133, 393–415 (2007). https://doi.org/10.1007/s11127-007-9196-3
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DOI: https://doi.org/10.1007/s11127-007-9196-3
Keywords
- Monetary union
- (Relative) Public debt
- Interest rates
- Externalities
- Substitutability
- Central bank independence