Working Paper: NBER ID: w25340
Authors: Javier Bianchi; Jorge Mondragon
Abstract: This paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary independence, lenders anticipate that the government would face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. In a quantitative application, we find that the lack of monetary autonomy played a central role in making Spain vulnerable to a rollover crisis during 2011-2012. Finally, we argue that a lender of last resort can go a long way towards reducing the costs of giving up monetary independence.
Keywords: monetary independence; rollover crises; sovereign debt; eurozone; lender of last resort
JEL Codes: E4; E5; F34; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of monetary independence (E49) | increased vulnerability to rollover crises (F65) |
| pessimism of lenders (G21) | demand-driven recession (E32) |
| demand-driven recession (E32) | increased likelihood of default (G33) |
| lack of monetary independence (E49) | increased likelihood of a run on government bonds (E44) |
| government with monetary independence (E58) | mitigates recession from rollover crisis (E44) |
| monetary independence (E49) | reduces chances of panic among investors (E44) |
| lack of monetary independence (E49) | higher vulnerability to rollover crises in monetary union (F36) |
| existence of a lender of last resort (E58) | reduces welfare costs of relinquishing monetary independence (J32) |