The paper extends the recent literature on collapsing managed exchange rate regimes by allowing explicitly for the qovernment budget constraint and the interest cost of servicing the public debt. The policy experivent that is analysed is the decision by a government to replenish its stock of foreign exchange reserve through a once-off open market sale of bonds. Without a fundanental fiscal correction (i.e. a decision to reduce the primary (non-interest) deficit by an amount equal to the increase in the interest cost of servicing the debt) the conseqinces are as follows. In a deterministic model the timing of the speculative attack is brought forward (delayed) if the borrowing takes place long before (close to) the date at which without borrowing the collapse would have occurred. The magnitude of the attack (the final loss of reserves) always increases because of borrowing. In a stochastic model, borrowing reduces the probability of an early collapse and increases the likelihood of a later collapse. Under mild conditions, the expected length of the time interval until the collapse occus is increased by borrowing.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
1844.
Length: Date of creation: Jan 1988 Date of revision: Handle: RePEc:nbr:nberwo:1844
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A. Craig Burnside & Martin S. Eichenbaum & Sergio Rebelo, 2003.
"On the Fiscal Implications of Twin Crises,"
NBER Chapters,
in: Managing Currency Crises in Emerging Markets, pages 187-224
National Bureau of Economic Research, Inc.
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