Working Paper: CEPR ID: DP1299
Authors: Roel M. W. J. Beetsma; A. Lans Bovenberg
Abstract: If discretionary monetary policy implies an inflation bias, monetary unification boosts the accumulation of public debt. The additional debt accumulation is welfare reducing only if governments are sufficiently myopic. In the presence of myopic governments, debt ceilings play a useful role in avoiding excessive debt accumulation in a monetary union and allow a conservative, independent central bank to focus on price stability.
Keywords: common central bank; monetary union; credibility effect; government myopia; price stability; optimal debt target
JEL Codes: E52; E58; E61; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary unification (F36) | higher public debt accumulation (H69) |
| lack of commitment of CCB (E58) | higher second-period inflation expectations (E31) |
| higher second-period inflation expectations (E31) | first-period fiscal policymakers reduce debt accumulation (E62) |
| first-period fiscal policymakers reduce debt accumulation (E62) | enhanced future credibility (D83) |
| lack of commitment of CCB (E58) | increased long-term inflation and public debt (H69) |
| myopic governments (H11) | excessive debt accumulation (F65) |
| excessive debt accumulation (F65) | reduced welfare (I38) |
| larger monetary unions (F45) | diminished benefits from reducing debt (G51) |
| optimal monetary arrangements (F33) | mitigate excessive debt accumulation effects (G51) |