Union Debt Management
(2016) , 54 pages
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- Abstract
- We study the role of government debt maturity in a monetary union in the absence of fiscal transfers across countries. Our key finding is that fiscal hedging is only possible when spending represents an aggregate shock in the union. In the case of idiosyncratic disturbances in spending it is not possible to target a portfolio which provides fiscal insurance to the governments: the allocation is one of incomplete financial markets. These implications are in line with the empirical evidence. Using a sample of 5 Euro area countries and historical holding period returns on government debt, we find that fiscal insurance is not signifi cant against country specific shocks however, it is significant against aggregate shocks. Our analysis extends the theoretical results of the literature on optimal fiscal policy without state contingent debt to a two country model. We show that in the two country setup and under an incomplete market the optimal tax schedule, consumption and leisure follow a random walk.
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Citations
Equiza-Goni, J., Faraglia, E., & Oikonomou, R. (2016). Union Debt Management (CEPR Discussion Paper 11181). https://hdl.handle.net/2078.5/186220