Regional debt in monetary unions: Is it inflationary?

Russell Cooper, Hubert Kempf, Dan Peled

Research output: Contribution to journalArticlepeer-review


This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with no inflationary consequences? Or will the circulation of region debt induce monetization by a central bank? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of regional debt holdings. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of some policy measures within a monetary union as well as dollarization.

Original languageEnglish
Pages (from-to)345-358
Number of pages14
JournalEuropean Economic Review
Issue number3
StatePublished - Apr 2010

Bibliographical note

Funding Information:
We are grateful to the CNRS and the NSF for financial support. Cooper thanks the Research Department at the Federal Reserve Bank of Minneapolis for its support. Helpful comments and questions from Maria Alzua, Marco Bassetto, Micha Ben-Gad, Eddie Dekel, Etienne Farvaque, Patrick Kehoe, Todd Keister, Robert E. Lucas, Henri Pagès, John Shea, and Yoram Weiss, as well as seminar participants at the European Central Bank, the Banque de France, the Federal Reserve Bank of Dallas, the Bank of Israel, the University of Maryland, Tel Aviv University, the University of Haifa, the Anglo-French seminar in macroeconomics, the European University Institute, the University of Pavia and the University of Bologna are very much appreciated. Comments and suggestions from Referees and the Editor of the EER are appreciated as well.


  • Commitment
  • Inflation
  • Monetary union
  • Multiple equilibria
  • Regional deficits

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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