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On the Fiscal Implications of Twin Crises

  • Burnside, Craig
  • Eichenbaum, Martin
  • Rebelo, Sérgio

This Paper explores the implications of different strategies for financing the fiscal costs of twin crises in inflation and depreciation rates. We use a first-generation type model of speculative attacks which has four key features: (i) the crisis is triggered by prospective deficits: (ii) there exists outstanding non-indexed government debt issued prior to the crises; (iii) a portion of the governments liabilities are not indexed to inflation; and (iv) there are nontradable goods and costs of distributing tradable goods, so that purchasing power parity does not hold. We show that the model can account for the high rates of devaluation and moderate rates of inflation often observed in the wake of currency crises. We use our model and the data to interpret the recent currency crises in Mexico and Korea. Our analysis suggests that the Mexican government is likely to pay for the bulk of the fiscal costs of its crisis through seignorage revenues. In contrast, the Korean government is likely to rely more on a combination of implicit and explicit fiscal reforms.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2918.

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Date of creation: Aug 2001
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Handle: RePEc:cpr:ceprdp:2918
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  1. 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.
  2. Michael P. Dooley, 1998. "A model of crises in emerging markets," International Finance Discussion Papers 630, Board of Governors of the Federal Reserve System (U.S.).
  3. Buiter, Willem H., 1987. "Borrowing to defend the exchange rate and the timing and magnitude of speculative attacks," Journal of International Economics, Elsevier, vol. 23(3-4), pages 221-239, November.
  4. Menzie D. Chinn & Kenneth M. Kletzer, 1999. "International capital inflows, domestic financial intermediation and financial crises under imperfect information," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
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