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130 Years of Fiscal Vulnerabilities and Currency Crashes in Advanced Economies

Listed author(s):
  • Marcel Fratzscher
  • Arnaud Mehl
  • Isabel Vansteenkiste

This paper investigates the empirical link between fiscal vulnerabilities and currency crashes in advanced economies over the last 130 years, building on a new data set of real effective exchange rates and fiscal balances for 21 countries since 1880. The paper finds evidence that crashes depend more on prospective fiscal deficits than on actual ones, and more on the composition of public debt (that is, rollover/sudden stop risk) than on its level. The paper also uncovers significant nonlinear effects at high levels of public debt as well as significantly negative risk premiums for major reserve currencies, which enjoy a lower probability of currency crash than other currencies ceteris paribus. Yet, the estimates indicate that such premiums remain small in size relative to the conditional probability of a currency crash if prospective fiscal deficits or rollover/sudden stop risk are high.

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Article provided by Palgrave Macmillan & International Monetary Fund in its journal IMF Economic Review.

Volume (Year): 59 (2011)
Issue (Month): 4 (November)
Pages: 683-716

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Handle: RePEc:pal:imfecr:v:59:y:2011:i:4:p:683-716
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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters,in: This Time Is Different: Eight Centuries of Financial Folly Princeton University Press.
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  15. Guillermo A. Calvo, 2006. "Monetary Policy Challenges in Emerging Markets: Sudden Stop, Liability Dollarization, and Lender of Last Resort," Research Department Publications 4504, Inter-American Development Bank, Research Department.
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