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Good Housekeeping? Reputation, Fixed Exchange Rates, and the 'Original Sin' Problem

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Kang Yong Tan
Prasanna Gai

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Abstract

This paper examines how the choice of exchange rate regime can signal financial rectitude and, in so doing, influcence a country's ability to borrow internationally in domestic currency. We develop a model in which the constant probability of a 'type change' creates incentives for disciplined policymakers to fix the exchange rate in an effort to separate themselves from more opportunistic types. Because the track record of a policymaker is imperfectly observable, reputational incentives depend on the past behaviour of previous generations and there is hysterisis in the updating behaviour of creditors. 'Original Sin' - the inflationary track record of one's predecessors - can reverberate over time leading creditors to be wary about extending sovereign loans in domestic currency terms. Our findings seem consistent with the pattern of the currency composition of debt in Japan and Russia at the turn of the nineteenth century.

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Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 446.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:feam04:446

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Related research
Keywords: International Monetary Arrangement; Foreign Currency Debt; Reputation;

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Find related papers by JEL classification:
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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  3. Drazen, Allan & Masson, Paul R, 1994. "Credibility of Policies versus Credibility of Policymakers," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 735-54, August. [Downloadable!] (restricted)
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  4. Falcetti, Elisabetta & Missale, Alessandro, 2002. "Public debt indexation and denomination with an independent central bank," European Economic Review, Elsevier, vol. 46(10), pages 1825-1850, December. [Downloadable!] (restricted)
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  5. Bordo, Michael D & Flandreau, Marc, 2001. "Core, Periphery, Exchange Rate Regimes and Globalization," CEPR Discussion Papers 3077, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Mailath, George J & Samuelson, Larry, 2001. "Who Wants a Good Reputation?," Review of Economic Studies, Blackwell Publishing, vol. 68(2), pages 415-41, April.
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  7. Koppl, Roger & Yeager, Leland B., 1996. "Big Players and Herding in Asset Markets: The Case of the Russian Ruble," Explorations in Economic History, Elsevier, vol. 33(3), pages 367-383, July. [Downloadable!] (restricted)
  8. Michael D. Bordo & Christopher Meissner & Angela Redish, 2003. "How "Original Sin" was Overcome: The Evolution of External Debt Denominated in Domestic Currencies in the United States and the British Dominions," NBER Working Papers 9841, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Tirole, Jean, 1996. "A Theory of Collective Reputations (with Applications to the Persistence of Corruption and to Firm Quality)," Review of Economic Studies, Blackwell Publishing, vol. 63(1), pages 1-22, January. [Downloadable!] (restricted)
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  12. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December. [Downloadable!] (restricted)
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  13. Obstfeld, Maurice & Taylor, Alan M, 2003. "Sovereign Risk, Credibility and the Gold Standard: 1870-1913 versus 1925-31," CEPR Discussion Papers 3688, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  14. 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. [Downloadable!]
  15. Nathan Sussman & Yishay Yafeh, 1998. "Institutions, Reforms, and Country Risk: Lessons from Japanese Government Debt in the Meiji Period," CIRJE F-Series CIRJE-F-20, CIRJE, Faculty of Economics, University of Tokyo.
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  17. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  18. Grossman, Herschel I. & Van Huyck, John B., 1993. "Nominal sovereign debt, risk shifting, and reputation," Journal of Economics and Business, Elsevier, vol. 45(3-4), pages 341-352. [Downloadable!] (restricted)
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  19. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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