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Sovereign Debt Booms in Monetary Unions

Author(s): Aguiar, Mark A.; Amador, Manuel; Farhi, Emmanuel; Gopinath, Gita

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Abstract: After joining the euro, several countries with a history of high inflation (notable examples include Greece and Italy) experienced sharp reductions in inflation together with a prolonged build up of sovereign debt. In this paper we propose a rationalization for this phenomenon. To do so, we explore the interaction between inflation credibility and the debt dynamics that arise when an impatient sovereign issues nominal bonds. We are particularly interested in the impact of an increase in inflation credibility, achieved either through better policies and institutions or by leveraging the higher inflation credibility of other countries via a currency union. We show that an increase in inflation credibility delivers an invitation to borrow, raising the maximum borrowing limit of the country and reducing any incentive to save.
Publication Date: May-2014
Citation: Aguiar, Mark A, Amador, Manuel, Farhi, Emmanuel, Gopinath, Gita. (2014). Sovereign Debt Booms in Monetary Unions. American Economic Review, 104 (5), 101 - 106. doi:10.1257/aer.104.5.101
DOI: doi:10.1257/aer.104.5.101
ISSN: 0002-8282
Pages: 101 - 106
Type of Material: Journal Article
Journal/Proceeding Title: American Economic Review
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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