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A Positive Theory of Foreign Currency Debt

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Author Info
Henning Bohn

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Abstract

The paper makes a case for foreign currency debt as a hedging device in an open economy subject to stochastic shocks to output. A government can reduce uncertainty in net wealth and in consumption by issuing foreign or domestic currency debt, if unexpected domestic and foreign inflation are negatively correlated with domestic output.

Foreign currency debt is desirable in comparison to domestic currency debt, if growth rates of output of both countries are closely related and if domestic inflation is relatively uncertain. In addition, foreign currency debt replaces domestic currency debt as hedge, whenever issuing domestic debt is prevented or discouraged by incentive problems.

It also shows that time-consistency problems may motivate capital controls or taxes on international borrowing.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 19-88.

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Handle: RePEc:fth:pennfi:19-88

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  1. Ilan Goldfajn & Marcos Antonio Silveira, 2002. "Should Government Smooth Exchange Rate Risk?," Working Papers Series 48, Central Bank of Brazil, Research Department. [Downloadable!]
  2. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 2001. "A Corporate Balance-Sheet Approach to Currency Crises," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 01.14, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
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  3. Gerardo M Licandro, 2001. "Monetary Policy Coordination, Monetary Integration and other essays," Levine's Working Paper Archive 625018000000000172, David K. Levine. [Downloadable!]
  4. John Y. Campbell, 1995. "Some Lessons from the Yield Curve," NBER Working Papers 5031, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Garima Vasishtha, 2007. "Domestic versus External Borrowing and Fiscal Policy in Emerging Markets," Working Papers 07-33, Bank of Canada. [Downloadable!]
  6. Cysne, Rubens Penha, 2005. "Public Debt Indexation and Denomination, The Case of Brazil: A Comment," Economics Working Papers (Ensaios Economicos da EPGE) 579, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
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  7. Uhlig, H., 1997. "Long term debt and the political support for a monetary union," Discussion Paper 13, Tilburg University, Center for Economic Research. [Downloadable!]
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  8. 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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  9. Alessandro Missale & Francesco Giavazzi & Pierpaolo Benigno, . "Managing the Public Debt in Fiscal Stabilizations: the Evidence," Working Papers 118, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
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  10. Philippe Bacchetta & Eric van Wincoop, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December. [Downloadable!] (restricted)
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  11. Ilan Goldfajn, 1998. "Public Debt Indexation and Denomination: The Case of Brazil," Working Papers Central Bank of Chile 27, Central Bank of Chile. [Downloadable!]
  12. Franz Hamann & Julián Pérez & Paulina Restrepo, 2005. "Sobre los Efectos Macroeconómicos de la Composición de la Deuda Pública en Colombia," BORRADORES DE ECONOMIA 003510, BANCO DE LA REPÚBLICA. [Downloadable!]
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  13. John Geanakoplos & Felix Kubler, 2003. "Dollar Denominated Debt and Optimal Security Design," Cowles Foundation Discussion Papers 1449, Cowles Foundation, Yale University. [Downloadable!]
  14. Olli Castrén & Tuomas Takalo, 2000. "Capital market development, corporate governance and the credibility of exchange rate pegs," Working Paper Series 34, European Central Bank. [Downloadable!]
  15. Olli Castren & Tuomas Takalo, 2000. "Capital Market Development, Corporate Governance and the Credibility of Exchange Rate Pegs," Econometric Society World Congress 2000 Contributed Papers 0515, Econometric Society. [Downloadable!]
  16. Melecky, Martin, 2009. "The Effect of Institutions, Geography, Development Assistance and Debt Crises on Public-Debt Management," MPRA Paper 16332, University Library of Munich, Germany. [Downloadable!]
  17. Alessandro Missale & Elisabetta Falcetti, . "Public Debt Indexation and Denomination with and Indipendent Central Bank," Working Papers 169, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
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  18. Rudi Dornbusch, 1996. "Debt and Monetary Policy: The Policy Issues," NBER Working Papers 5573, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Melecky, Martin, 2008. "An alternative framework for foreign exchange risk management of sovereign debt," Policy Research Working Paper Series 4458, The World Bank. [Downloadable!]
  20. Olli Castrén & Tuomas Takalo & Geoffrey Wood, 2004. "Labour market reform and the sustainability of exchange rate pegs," Working Paper Series 406, European Central Bank. [Downloadable!]
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