Sovereign Debt and Monetary Unions - The case of Italy

Details

Supervisors

Pensieroso, Luca

Faculty

Faculté des sciences économiques, sociales, politiques et de communication

Degree label

Master [120] en sciences économiques, orientation générale

Abstract

One of the main reasons for the creation of a monetary union in Europe in 1999 was to put an end to the post-war currency crises in the region and to ensure price stability among Eurozone member States. However, it has been done at the price of an important instrument: the loss of control on national currency emissions and therefore, on monetary policy. Such a cost has important implications for sovereign defaults, as it deprives to print money in order to pay back treasury bonds’ holders when a country faces fiscal issues. This makes him more vulnerable to movements of distrust in sovereign bond markets and self-fulfilling prophecies. At the end of 2019, Italy faces fiscal issues and is currently at risk of defaulting on its debt. If a default happens, the collapse of the Italian State could go hand in hand with a collapse of many Italian banks. In this case, the choice of partial default through inflation might be seen as an attractive solution, less heavy in terms of welfare losses than a sovereign default since it could prevent a twin crisis from happening. The aim of this work is to assess whether or not the loss of monetary independence and fiscal rigidities imposed by the Stability and Growth Pact in countries lying in the Eurozone with important difficulties to service their debt can be harmful when sovereign default risk rises. In order to assess this, I’ve used a comparative SVAR analysis to characterize the dynamic effects of a shock in public spending, in order to trigger public imbalances to the Italian economy (output, inflation, public debt, and the spread) in both pre-Eurozone (1979-1998) and post-Eurozone (1999-2019) periods. After that, the same methodology was applied respectively for France, Argentina, and Japan. The only exception is Argentina in 1979-1998 because of the lack of data. The choice of the first period coincides with the creation of the European Monetary System until the creation of the Eurozone, as the second one begins with the creation of the European Monetary Union. The results show evidence that the current structures of the Eurozone do seem to hamper Italy’s capability to cope with a shock that triggers public imbalances compared to the pre-EU period. In fact, the two European countries face a more important and longer crisis after the entrance in the Eurozone as well as higher fluctuations in the spread. Italy seems to face a sovereign default dynamic like in Bocola et al. (2019). However, I found no homogeneity among stand-alone countries in the way they react to a shock in public spending across both periods. The cases of Japan in 1979-1998 and Argentina in 1999-2019 show there is absolutely no evidence that a country with important fiscal issues is better off alone than in a monetary union. This could lead us to believe that national structures and historical contexts are more important in sovereign default dynamics than the fact of being in a monetary union.