Monetary Revenues and Fiscal Distress in the European Monetary Union

Is it a coincidence that those members of the Economic and Monetary Union (EMU) which have experienced episodes of severe fiscal distress relied on sizable seigniorage revenues prior to joining the EMU? In other words, can a restriction on monetary revenues outweigh the gains of committed monetary policy from a fiscal policy perspective? To answer this question, I develop a framework which allows to compare the optimal choices of a government with limited fiscal commitment and different degrees of monetary policy independence. Specifically, I introduce a nominal friction and monetary policy into a canonical model of sovereign default. In this environment, I conduct an experiment which captures the transition from a regime of discretionary monetary policy to one in which it is following an (exogenous) rule. Hence, I am able to study how the desirability of sovereign default differs in the two regimes as well as along the transition path.