American Economic Review: Vol. 104 No. 5 (May 2014)

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Sovereign Debt Booms in Monetary Unions

Article Citation

Aguiar, Mark, Manuel Amador, Emmanuel Farhi, and Gita Gopinath. 2014. "Sovereign Debt Booms in Monetary Unions." American Economic Review, 104(5): 101-06.

DOI: 10.1257/aer.104.5.101

Abstract

We propose a continuous time model to investigate the impact of inflation credibility on sovereign debt dynamics. At every point in time, an impatient government decides fiscal surplus and inflation, without commitment. Inflation is costly, but reduces the real value of outstanding nominal debt. In equilibrium, debt dynamics is the result of two opposing forces: (i) impatience and (ii) the desire to conquer low inflation. A large increase in inflation credibility can trigger a process of debt accumulation. This rationalizes the sovereign debt booms that are often experienced by low inflation credibility countries upon joining a currency union.

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Authors

Aguiar, Mark (Princeton U)
Amador, Manuel (Federal Reserve Bank of Minneapolis)
Farhi, Emmanuel (Harvard U)
Gopinath, Gita (Harvard U)

JEL Classifications

E31: Price Level; Inflation; Deflation
E43: Interest Rates: Determination, Term Structure, and Effects
F33: International Monetary Arrangements and Institutions
H63: National Debt; Debt Management; Sovereign Debt


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