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Nominal Debt and the Dynamics of Currency Crises

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  • Corsetti, Giancarlo
  • Mackowiak, Bartosz Adam

Abstract

This Paper proposes a new framework for interpreting a currency crisis associated with a fiscal imbalance, which we find appropriate for the analysis of contemporary economies with outstanding public debt. Unlike the first-generation literature on speculative attacks, we do not assume that money growth finances the imbalance and that governments face exogenous borrowing constraints. In our model, the cause of a devaluation is a fiscal policy switch, from a policy-backing government debt fully with taxes, to one using taxes and unanticipated inflation. Its timing depends on the interaction of fiscal and monetary policy, where the latter is modelled in terms of interest rate rules. Real debt acts as leverage, and the rate of devaluation is smaller when nominal liabilities are a larger fraction of the total. The focus of our analysis of currency crises is on currency of denomination and maturity of government debt; the government's willingness to tolerate high interest rates; the possibility of coordination problems among holders of government debt.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2929.

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Date of creation: Aug 2001
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Handle: RePEc:cpr:ceprdp:2929

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Keywords: currency crisis; fiscal theory of the price level; speculative attack;

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Cited by:
  1. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2003. "Government Finance in the Wake of Currency Crises," NBER Working Papers 9786, National Bureau of Economic Research, Inc.
  2. Craig Burnside, 2004. "The Research Agenda: Craig Burnside on the Causes and Consequences of Twin Banking-Currency Crises," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 5(2), April.
  3. 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.
  4. Fan, Jingwen & Minford, Patrick, 2010. "Can the Fiscal Theory of the price level explain UK inflation in the 1970s?," CEPR Discussion Papers 7630, C.E.P.R. Discussion Papers.
  5. Maltritz, Dominik, 2008. "Modelling the dependency between currency and debt crises: An option based approach," Economics Letters, Elsevier, vol. 100(3), pages 344-347, September.
  6. António Afonso, 2002. "Disturbing the fiscal theory of the price level: Can it fit the eu-15?," 10th International Conference on Panel Data, Berlin, July 5-6, 2002 B4-3, International Conferences on Panel Data.
  7. Corsetti, Giancarlo & Mackowiak, Bartosz, 2006. "Fiscal imbalances and the dynamics of currency crises," European Economic Review, Elsevier, vol. 50(5), pages 1317-1338, July.
  8. Burnside, Craig, 2004. "Currency crises and contingent liabilities," Journal of International Economics, Elsevier, vol. 62(1), pages 25-52, January.
  9. Richard Hemming & Axel Schimmelpfennig & Michael Kell, 2003. "Fiscal Vulnerability and Financial Crises in Emerging Market Economies," IMF Occasional Papers 218, International Monetary Fund.

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