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Exchange Rate Crises and Fiscal Solvency

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  • BETTY C. DANIEL

Abstract

This paper combines insights from generation one currency crisis models and the fiscal theory of the price level (FTPL) to create a dynamic FTPL model of currency crises. The initial fixed-exchange-rate policy entails risks due to an upper bound on government debt and stochastic surplus shocks. Agents refuse to lend into a position for which the value of debt exceeds the present value of expected future surpluses. Policy switching, usually combined with currency depreciation, restores fiscal solvency and lending. This model can explain a wide variety of crises, including those involving sovereign default. We illustrate by explaining the crisis in Argentina (2001). Copyright (c) 2010 The Ohio State University.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 42 (2010)
Issue (Month): 6 (09)
Pages: 1109-1135

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Handle: RePEc:mcb:jmoncb:v:42:y:2010:i:6:p:1109-1135

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  1. Uribe, Martín, 2002. "A fiscal theory of sovereign risk," Working Paper Series 0187, European Central Bank.
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Cited by:
  1. Sottile, Pedro, 2013. "On the political determinants of sovereign risk: Evidence from a Markov-switching vector autoregressive model for Argentina," Emerging Markets Review, Elsevier, vol. 15(C), pages 160-185.
  2. Betty Daniel & Christos Shiamptanis, 2008. "Fiscal Policy in the European Monetary Union," Discussion Papers 08-11, University at Albany, SUNY, Department of Economics.
  3. Daniel, Betty C. & Shiamptanis, Christos, 2013. "Pushing the limit? Fiscal policy in the European Monetary Union," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2307-2321.
  4. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
  5. Betty Daniel & Christos Shiamptanis, 2008. "Fiscal Risk in a Monetary Union," Discussion Papers 08-12, University at Albany, SUNY, Department of Economics.

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