Monetary Independence and Rollover Crises

Bianchi, Javier; Mondragon, Jorge

doi:10.21034/wp.755

Working Paper

Monetary Independence and Rollover Crises

Abstract: This paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary autonomy, lenders anticipate that the government will face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. By contrast, a government with monetary autonomy can stabilize the economy and can easily remain immune to a rollover crisis. In a quantitative application, we find that the lack of monetary autonomy played a central role in making the Eurozone vulnerable to a rollover crisis. A lender of last resort can help ease the costs from giving up monetary independence.

Keywords: Sovereign debt crises; Rollover risk; monetary unions;

JEL Classification: E4; E5; F34; G15;

https://doi.org/10.21034/wp.755