INTEREST-RATES AND FISCAL DISCIPLINE IN MONETARY UNIONS

This paper compares market-generated incentives affecting the design o f national fiscal policies in a monetary union regime with those corre sponding to a fixed-exchange-rate regime of limited credibility. The a nalysis is based on a simple model that yields equilibrium interest ra tes in the two regimes as a function of the degree of a government's f inancial and fiscal discipline. It is found that market-based mechanis ms for fiscal and financial discipline under a monetary union are only more powerful than under the alternative fixed-exchange regime if gov ernments are not heavily indebted.