The evolution of debtor-creditor relationships within a monetary union: Trade imbalances, excess reserves and economic policy

Abstract

This paper analyzes the emergence of internal debtor-creditor relationships within a monetary union. We develop a stock-flow consistent model consisting of three regions – North, South, and the Rest of the World (RoW) –, where North and South form a monetary union. We show how the simultaneous presence of investment booms, declining export performance and mercantilist policies within a monetary union can interact in order to create Minsky-type boom-bust cycles. Fiscal policy and a Eurozone lender of last resort can help sustain economic life under existing structural imbalances, but without eliminating the root causes of boom-bust patterns.