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The Currency Denomination of Public Debt and the Choice of the Monetary Regime

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  • E Falcetti
  • S Milner
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    Abstract

    This paper examines the interactions between monetary regimes and public debt management. The analysis shows that delegation of monetary policy to an independent central bank is more effective in containing inflationary expectations than the use of foreign currency or price-indexed debt. If delegation of monetary policy is viable, the optimal policy is to issue conventional debt so as to reduce the cost of supply shocks and thus the need for policy accommodation. The role of debt management changes in a fixed exchange regime, since foreign currency debt may enhance the credibility of the peg. However, if a crisis nevertheless materialises, it would be worse than had foreign debt not been issued. Empirical evidence on the EMS appears to support this result. Probit estimates show that the decision to issue foreign currency debt significantly reduced the likelihood of an official realignment within the ERM. However, conditional on a crisis taking place, those countries that increased the share of foreign currency debt experienced larger devaluation sizes.

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    Bibliographic Info

    Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0427.

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    Date of creation: Jun 1999
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    Handle: RePEc:cep:cepdps:dp0427

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    Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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    Cited by:
    1. Banerjee, Abhijit & Bacchetta, Philippe & Aghion, Philippe, 2001. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," Scholarly Articles 4554218, Harvard University Department of Economics.
    2. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2004. "A corporate balance-sheet approach to currency crises," Journal of Economic Theory, Elsevier, vol. 119(1), pages 6-30, November.
    3. Jeanne, Olivier, 2000. "Foreign currency debt and the global financial architecture," European Economic Review, Elsevier, vol. 44(4-6), pages 719-727, May.

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