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Fiscal Deficits, Exchange Rate Crises and Inflation

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  • Sweder van Wijnbergen

Abstract

This paper extends earlier work on unsustainable monetary policies by endogenizing the regime switch that ultimately restores sustainability. Within this framework we analyse exchange rate based stabilization programmes and show how constraints on Central Bank borrowing during an exchange crisis influence timing and nature of the post-collapse equilibrium. Such constraints introduce non-neutralities; more restrictive pre-collapse credit policies increase the post-collapse inflation rate. External shocks can destroy consistency between fiscal programmes and inflation targets, causing reserve losses, exchange rate changes and higher inflation. Balance of Payments crises are the mechanism through which fiscal imbalances translate into higher inflation rather than an alternative explanation of it.

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  • Sweder van Wijnbergen, 1991. "Fiscal Deficits, Exchange Rate Crises and Inflation," Review of Economic Studies, Oxford University Press, vol. 58(1), pages 81-92.
  • Handle: RePEc:oup:restud:v:58:y:1991:i:1:p:81-92.
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    Cited by:

    1. Flood, Robert P. & Jeanne, Olivier, 2005. "An interest rate defense of a fixed exchange rate?," Journal of International Economics, Elsevier, vol. 66(2), pages 471-484, July.
    2. Nakatani, Ryota, 2018. "Adjustment to negative price shocks by a commodity exporting economy: Does exchange rate flexibility resolve a balance of payments crisis?," Journal of Asian Economics, Elsevier, vol. 57(C), pages 13-35.
    3. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2006. "Government finance in the wake of currency crises," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 401-440, April.
    4. Daniel, Betty C, 2001. "A Fiscal Theory of Currency Crises," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 969-988, November.
    5. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2001. "Prospective Deficits and the Asian Currency Crisis," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1155-1197, December.
    6. Nina Budina & Sweder Van Wijnbergen, 2001. "Fiscal deficits, monetary reform and inflation stabilization in romania," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 4(3), pages 165-194.
    7. Alexis Cruz-Rodríguez, 2014. "Is there a relationship between fiscal sustainability and currency crises? International evidence based on causality tests," International Journal of Business and Economic Sciences Applied Research (IJBESAR), Eastern Macedonia and Thrace Institute of Technology (EMATTECH), Kavala, Greece, vol. 7(1), pages 69-87, April.
    8. de Jong, F.C.J.M., 1993. "Empirical studies on exchange rate target zones and the microstructure of securities markets," Other publications TiSEM 5dd3028d-662c-415a-ba9d-2, Tilburg University, School of Economics and Management.
    9. Ritu Anand & Sweder van Wijnbergen, 1988. "Inflation, External Debt and Financial Sector Reform: A Quantitative Approach To Consistent Fiscal Policy With An Application to Turkey," NBER Working Papers 2731, National Bureau of Economic Research, Inc.
    10. Craig Burnside, 2004. "The Research Agenda: Craig Burnside on the Causes and Consequences of Twin Banking-Currency Crises," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 5(2), April.
    11. Ryota Nakatani, 2017. "External Adjustment in a Resource-Rich Economy: The Case of Papua New Guinea," IMF Working Papers 17/267, International Monetary Fund.
    12. Donyina-Ameyaw, Samuel, 2004. "A Small Macroeconmetric Model Of Trade And Inflation In Ghana," The Warwick Economics Research Paper Series (TWERPS) 696, University of Warwick, Department of Economics.
    13. Amato, Amedeo & Tronzano, Marco, 2000. "Fiscal policy, debt management and exchange rate credibility: Lessons from the recent Italian experience," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 921-943, June.
    14. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    15. Norbert Fiess & Rashmi Shankar, 2005. "Regime-Switching in Exchange Rate Policy and Balance Sheet Effects," Working Papers 2005_16, Business School - Economics, University of Glasgow.
    16. van Wijnbergen, Sweder & Rocha, Robert & Anand, Ritu, 1989. "Inflation, external debt, and financial sector reform : a quantitative approach to consistent fiscal policy," Policy Research Working Paper Series 261, The World Bank.
    17. Burnside, Craig, 2004. "Currency crises and contingent liabilities," Journal of International Economics, Elsevier, vol. 62(1), pages 25-52, January.
    18. Willman, Alpo, 1988. "Devaluation expectations and speculative attacks on the currency," Research Discussion Papers 8/1988, Bank of Finland.
    19. Alexis Cruz Rodriguez, 2011. "Prediction of Currency Crises Using a Fiscal Sustainability Indicator," Revista de Analisis Economico – Economic Analysis Review, Universidad Alberto Hurtado/School of Economics and Business, vol. 26(2), pages 39-60, December.
    20. Olivier Jeanne, 1996. "Les modèles de crise de change : un essai de synthèse en relation avec la crise du franc de 1992-1993," Économie et Prévision, Programme National Persée, vol. 123(2), pages 147-162.
    21. Cruz-Rodríguez, Alexis, 2015. "Sostenibilidad fiscal y crisis cambiarias: Un análisis empírico
      [Fiscal sustainability and currency crises: An empirical analysis]
      ," MPRA Paper 67741, University Library of Munich, Germany.
    22. Sylvester C. W. Eijffinger & Benedikt Goderis, 2007. "Currency Crises, Monetary Policy and Corporate Balance Sheets," German Economic Review, Verein für Socialpolitik, vol. 8, pages 309-343, August.
    23. Cruz-Rodriguez, Alexis, 2014. "¿Puede un índice de sostenibilidad fiscal predecir la ocurrencia de crisis cambiarias? Evidencias para algunos países seleccionados
      [Can a fiscal sustainability indicator predict the occurrence of
      ," MPRA Paper 54103, University Library of Munich, Germany.

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