Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/152854 
Year of Publication: 
2004
Series/Report no.: 
ECB Working Paper No. 420
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
We show how in a Blanchard-Yaari, overlapping generations framework, perfect substitutability of government bonds in Monetary Union tempts governments to exploit the enlarged common pool of savings. In Nash equilibrium all governments increase their bond financed transfers to current generations (prosperity effect) at the expense of future generations (posterity effect). The resulting deficit bias occurs even if one assumes that before Monetary Union countries had eliminated their deficit bias by designing appropriate domestic institutions. The paper provides a rationale for an increased focus on fiscal discipline in Monetary Union, without the need to assume imperfect credibility of existing Treaty provisions or to refer to extreme situations involving sovereign default. We draw on existing empirical evidence to argue that the degree of government bond substitutability within the European Monetary Union is an order of magnitude larger than in the global economy.
Subjects: 
bond market integration
common pool
European Monetary Union
fiscal discipline
fiscal rules
fiscal spillover effects
overlapping generations
JEL: 
D62
E61
E63
Document Type: 
Working Paper

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