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The Other Twins: Currency and Debt Crises

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Author Info
Bernhard Herz ()
Christian Bauer ()
Volker Karb ()

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Abstract

Empirically, currency crises are more frequently accompanied by simultaneous sovereign debt crises than by banking crises. Nevertheless the phenomenon of twin currency and debt crises has so far been treated in economic literature only sparsely. We analyse the optimal policy of a government that may choose and combine two policy alternatives. She may choose at the same time whether to keep or alternatively exit an existing exchange rate peg and whether or not to default on her debt. Both parameters have a large impact not only on the public welfare but on the government’s budget as well. The resulting incentive system can generate situations with self-fulfilling expectations. In some situations an internal contagion effect arises. A crisis in the sovereign debt market spreads to the sector of exchange rate policy and causes a devaluation as well. Private investors’ default expectations thus can not only cause a sovereign debt crisis but may lead to a currency crisis as well.

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File URL: http://www.eea-esem.com/papers/eea-esem/2003/1225/The%20Other%20Twins%20-%20Currency%20and%20Debt%20Crises.pdf
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Publisher Info
Article provided by Department of Economics, Economics I, Bayreuth University in its journal Review of Economics.

Volume (Year): 54 (2003)
Issue (Month): 3 ()
Pages: 248-267
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Handle: RePEc:uba:hadfwe:theothertwins-herz-bauer-karb-2003-01

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Related research
Keywords: Currency crises; internal contagion; self-fulfilling expectations and sovereign debt;

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Find related papers by JEL classification:
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Axel Dreher & Bernhard Herz & Volker Karb, 2006. "Is there a causal link between currency and debt crises?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(4), pages 305-325. [Downloadable!]
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