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Foreign Debt and Fear of Floating: A Theoretical Exploration

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  • Michael Bleaney
  • F. Gulcin Ozkan

Abstract

This paper explores the relationship between the denomination of public debt and the choice of exchange rate regime. Unlike indexed domestic debt, foreign debt is subject to valuation effects from real exchange rate shocks. In a standard set-up, where a peg functions only as a nominal anchor, more foreign debt makes pegging less attractive, because it increases the value of a fexible exchange rate as a shock absorber. This result can be reversed if we incorporate the stylized fact that pegs have lower real exchange rate volatility, and if external shocks are sufficiently large relative to domestic shocks.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 08/10.

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Date of creation: May 2008
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Handle: RePEc:yor:yorken:08/10

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Keywords: inflation; output; public debt and exchange rate regimes.;

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  1. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
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  21. Michael Bleaney & Manuela Francisco, 2008. "Balance sheet effects and the choice of exchange rate regime in developing countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 17(2), pages 297-310.
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