DP3491 The Effect of Monetary Unification on Public Debt and its Real Return

Author(s): Roel Beetsma, Koen Vermeylen
Publication Date: August 2002
Keyword(s): (relative) public debt, central bank independence, externalities, monetary union, real interest rates, substitutability
JEL(s): E42, E62, E63, F33
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3491

We explore the implications of monetary unification for real interest rates and (relative) public debt levels. The adoption of a common monetary policy renders the risk-return characteristics of the participating countries more similar, so that the substitutability of their public debt increases after unification. This implies that the average expected real return on this debt increases. Also, the share of the debt issued by relatively short-sighted governments, or by countries that initially have a relatively dependent central bank, increases after unification. A transfer scheme that penalizes debt increases beyond the union average is able to undo the interest rate effect of unification, but further magnifies the spread of the relative debt levels.