Aguiar, Mark, Manuel Amador, Emmanuel Farhi and Gita Gopinath. “Coordination and Crisis in Monetary Unions.” The Quarterly Journal of Economics (2015) 130 (4): 1727-1779.


We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to overborrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.


    author = {Aguiar, Mark and Amador, Manuel and Farhi, Emmanuel and Gopinath, Gita},
    title = {Coordination and Crisis in Monetary Unions},
    volume = {130},
    number = {4},
    pages = {1727-1779},
    year = {2015},
    doi = {10.1093/qje/qjv022},
    URL = {http://qje.oxfordjournals.org/content/130/4/1727.abstract},
    journal = {The Quarterly Journal of Economics}