Political support to public debt repudiation in a Monetary Union - the role of the geographical allocation of debt.

The main arguments for the Stability and Growth Pact turn on the need to protect the European Central Bank against inflationary pressures from the fiscally prodigal countries (repudiation through inflation). Taking a political economy approach, in this paper we inquire into the conditions under which national governments may reach the decision for a partial or total repudiation of their debt. The main result produced by our model is that a debt management policy of lowering effective yields might be the dominant option for a self-interested government whose creditors consist in part of non-residents. On the basis of such result we argue that the impact of the fiscal position of the various member countries on the stability of EMU does not depend on the stock of debt but on the proportion of it that is held abroad.