New Delhi: The lack of monetary autonomy can destabilize an economy and make it more vulnerable to debt-related crises, says a new National Bureau of Economic Research working paper by Javier Bianchi of the Federal Reserve Bank of Minneapolis and Jorge Mondragon of the University of Minnesota.

To show this, the authors built a model of an economy which experiences income shocks and uses government borrowing to smooth over these shocks.

In this model, during times of recession, governments would need to roll over their debt (borrow more to pay off their initial debt). They would also have to resort to other measures such as tightening spending or increasing tax revenue. These fiscal measures can decrease aggregate demand and generate unemployment. If the economy, such as those in the Eurozone, cannot adjust monetary policy accordingly to compensate for this, then lenders will anticipate default and be unwilling to roll over the government’s debt.

This leads to a self-fulfilling default of government debt and generates a rollover crisis.

The authors conclude that lack of monetary independence increases vulnerability to a rollover crisis and argue that this is what happened in Spain a few years ago. The Spanish economy suffered considerably amid the turmoil in the debt markets around 2012. They find that, had Spain exited the Eurozone in 2012 and obtained monetary independence, the crisis would have been avoided because it could have used monetary policy to stabilize its economy.

Also read: Monetary Independence And Rollover Crises

Close