Is it is or is it Ain't My Obligation? Regional Debt in Monetary Unions

This paper studies the implications of the circulation of interest bearing regional debt in a monetary union. Does the circulation of this debt have the same monetary implications as the printing of money by a central government? Or are the obligations of this debt simply backed by future taxation with no inflationary consequences? We argue here that both outcomes can arise in equilibrium. In the model economy we consider 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 the holdings of the regional debt. We use the model to assess the impact of policy measures, such as fiscal restrictions, within a monetary union