Leith, C. and Wren-Lewis, S. (2011) Discretionary policy in a monetary union with sovereign debt. European Economic Review, 55(1), pp. 93-117. (doi: 10.1016/j.euroecorev.2010.11.007)
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Abstract
This paper examines the interactions between multiple national fiscal policymakers and a single monetary policy maker in response to shocks to government debt in some or all of the countries of a monetary union. We assume that national governments respond to excess debt in an optimal manner, but that they do not have access to a commitment technology. This implies that national fiscal policy gradually reduces debt: the lack of a commitment technology precludes a random walk in steady-state debt, but the need to maintain national competitiveness avoids excessively rapid debt reduction. If the central bank can commit, it adjusts its policies only slightly in response to higher debt, allowing national fiscal policy to undertake most of the adjustment. However, if it cannot commit, then optimal monetary policy involves using interest rates to rapidly reduce debt, with significant welfare costs. We show that in these circumstances the central bank would do better to ignore national fiscal policies in formulating its policy.
| Item Type: | Articles |
|---|---|
| Status: | Published |
| Refereed: | Yes |
| Glasgow Author(s) Enlighten ID: | Leith, Professor Campbell |
| Authors: | Leith, C., and Wren-Lewis, S. |
| College/School: | College of Social Sciences > Adam Smith Business School > Economics |
| Journal Name: | European Economic Review |
| Publisher: | Elsevier |
| ISSN: | 0014-2921 |
| Copyright Holders: | Copyright © 2011 Elsevier |
| First Published: | First published in European Economic Review 55(1):93-117 |
| Publisher Policy: | Reproduced in accordance with the copyright policy of the publisher |
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