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  3. American Economic Review
  4. May 2014
  5. Sovereign Debt Booms in Monetary Unions

Sovereign Debt Booms in Monetary Unions

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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.

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

Additional Materials

JEL Classification

  • 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