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130 years of fiscal vulnerabilities and currency crashes in advanced economies

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  • Fratzscher, Marcel
  • Mehl, Arnaud
  • Vansteenkiste, Isabel

Abstract

This paper investigates the empirical link between fiscal vulnerabilities and currency crashes in advanced economies over the last 130 years, building on a new dataset of real effective exchange rates and fiscal balances for 21 countries since 1880. We find evidence that crashes depend more on prospective fiscal deficits than on actual ones, and more on the composition of public debt (i.e. rollover/sudden stop risk) than on its level per se. We also uncover significant nonlinear effects at high levels of public debt as well as significantly negative risk premia for major reserve currencies, which enjoy a lower probability of currency crash than other currencies ceteris paribus. Yet, our estimates indicate that such premia remain small in size relative to the conditional probability of a currency crash if prospective fiscal deficits or rollover/sudden stop risk are high. This suggests that a currency’s international status is not necessarily sufficient to shelter it from collapse.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8612.

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Date of creation: Oct 2011
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Handle: RePEc:cpr:ceprdp:8612

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Keywords: advanced economies; banking crises; currency crashes; exchange rates; fiscal vulnerability; foreign debt; reserve currencies; total debt level;

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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Bussiere, Matthieu & Fratzscher, Marcel, 2006. "Towards a new early warning system of financial crises," Journal of International Money and Finance, Elsevier, vol. 25(6), pages 953-973, October.
  3. International Monetary Fund, 2010. "A Historical Public Debt Database," IMF Working Papers 10/245, International Monetary Fund.
  4. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "The Aftermath of Financial Crises," American Economic Review, American Economic Association, vol. 99(2), pages 466-72, May.
  5. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "The Forgotten History of Domestic Debt," Economic Journal, Royal Economic Society, vol. 121(552), pages 319-350, 05.
  6. Bordo, Michael D. & Rockoff, Hugh, 1996. "The Gold Standard as a “Good Housekeeping Seal of Approval”," The Journal of Economic History, Cambridge University Press, vol. 56(02), pages 389-428, June.
  7. Guillermo A. Calvo, 2006. "Monetary Policy Challenges in Emerging Markets: Sudden Stop, Liability Dollarization, and Lender of Last Resort," IDB Publications 6841, Inter-American Development Bank.
  8. Reinhart, Carmen & Rogoff, Kenneth, 2010. "Growth in a Time of Debt," CEPR Discussion Papers 7661, C.E.P.R. Discussion Papers.
  9. Reinhart, Carmen M. & Rogoff, Kenneth S., 2010. "Growth in a Time of Debt," Scholarly Articles 11129154, Harvard University Department of Economics.
  10. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  11. Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank.
  12. Mehl, Arnaud & Reynaud, Julien, 2010. "Risky public domestic debt composition in emerging economies," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 1-18, February.
  13. Moritz Schularick & Alan M. Taylor, 2012. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review, American Economic Association, vol. 102(2), pages 1029-61, April.
  14. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  15. Benigno, Pierpaolo & Missale, Alessandro, 2001. "High Public Debt in Currency Crises: Fundamentals versus Signalling Effects," CEPR Discussion Papers 2862, C.E.P.R. Discussion Papers.
  16. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(3), pages 291-299, September.
  17. Michael D. Bordo & Christopher M. Meissner & David Stuckler, 2009. "Foreign Currency Debt, Financial Crises and Economic Growth: A Long Run View," NBER Working Papers 15534, National Bureau of Economic Research, Inc.
  18. Michael D. Bordo & Christopher M. Meissner, 2005. "The Role of Foreign Currency Debt in Financial Crises: 1880-1913 vs. 1972-1997," NBER Working Papers 11897, National Bureau of Economic Research, Inc.
  19. Carmen M. Reinhart, 2010. "This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises," NBER Working Papers 15815, National Bureau of Economic Research, Inc.
  20. Reinhart, Carmen M. & Rogoff, Kenneth S., 2009. "The Aftermath of Financial Crises," Scholarly Articles 11129155, Harvard University Department of Economics.
  21. Reinhart, Carmen & Calvo, Guillermo, 1999. "Capital Flow Reversals,the Exchange Rate Debate,and Dollarization," MPRA Paper 8951, University Library of Munich, Germany.
  22. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
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Cited by:
  1. Eichengreen, Barry & Mehl, Arnaud & Chiţu, Livia, 2012. "When did the dollar overtake sterling as the leading international currency? Evidence from the bond markets," Working Paper Series 1433, European Central Bank.
  2. Douglas Sutherland & Peter Hoeller, 2012. "Debt and Macroeconomic Stability: An Overview of the Literature and Some Empirics," OECD Economics Department Working Papers 1006, OECD Publishing.
  3. Reinhart, Carmen M. & Rogoff, Kenneth S., 2008. "Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison," Scholarly Articles 11129156, Harvard University Department of Economics.

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