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Exchange Rate Crises and Fiscal Solvency

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  • BETTY C. DANIEL

Abstract

This paper combines insights from generation one currency crisis models and the fiscal theory of the price level (FTPL) to create a dynamic FTPL model of currency crises. The initial fixed-exchange-rate policy entails risks due to an upper bound on government debt and stochastic surplus shocks. Agents refuse to lend into a position for which the value of debt exceeds the present value of expected future surpluses. Policy switching, usually combined with currency depreciation, restores fiscal solvency and lending. This model can explain a wide variety of crises, including those involving sovereign default. We illustrate by explaining the crisis in Argentina (2001). Copyright (c) 2010 The Ohio State University.

Suggested Citation

  • Betty C. Daniel, 2010. "Exchange Rate Crises and Fiscal Solvency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1109-1135, September.
    • Handle: RePEc:mcb:jmoncb:v:42:y:2010:i:6:p:1109-1135
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    Cited by:

    1. Daniel, Betty C. & Shiamptanis, Christos, 2013. "Pushing the limit? Fiscal policy in the European Monetary Union," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2307-2321.
    2. Sottile, Pedro, 2013. "On the political determinants of sovereign risk: Evidence from a Markov-switching vector autoregressive model for Argentina," Emerging Markets Review, Elsevier, vol. 15(C), pages 160-185.
    3. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
    4. Betty C. Daniel & Christos Shiamptanis, 2008. "Fiscal policy in the European Monetary Union," International Finance Discussion Papers 961, Board of Governors of the Federal Reserve System (U.S.).
    5. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.

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