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Good Housekeeping? Reputation, Fixed Exchange Rates, and the 'Original Sin' Problem

  • Prasanna Gai

    (Australian National University)

  • Kang-yong Tan

    (Australian National University)

This paper examines how the choice of exchange rate regime can signal financial rectitude and, in so doing, influence a country¡¦s ability to borrow internationally in domestic currency. We develop a model in which the constant probability of a ¡¥type change¡¦ creates incentives for disciplined policymakers to fix the exchange rate in an effort to separate themselves from more opportunistic types. Because the track record of a policymaker is imperfectly observable, reputational incentives depend on the past behaviour of previous generations and there is hysterisis in the updating behaviour of creditors. ¡¥Original sin¡¦ ¡V the inflationary track record of one¡¦s predecessors ¡V can reverberate over time leading creditors to be wary about extending sovereign loans in domestic currency terms. Our findings seem consistent with the pattern of the currency composition of debt in Japan and Russia at the turn of the nineteenth century.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 082004.

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Length: 23 pages
Date of creation: Apr 2004
Date of revision:
Handle: RePEc:hkm:wpaper:082004
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  1. Steve Tadelis, 1997. "What's in a Name? Reputation as a Tradeable Asset," Working Papers 97033, Stanford University, Department of Economics.
  2. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  3. Herschel I. Grossman & John B. Van Huyck, 1987. "Nominally Sovereign Debt, Risk Shifting, and Reputation," NBER Working Papers 2259, National Bureau of Economic Research, Inc.
  4. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
  5. Michael D. Bordo & Christopher Meissner & Angela Redish, 2003. "How "Original Sin" was Overcome: The Evolution of External Debt Denominated in Domestic Currencies in the United States and the British Dominions," NBER Working Papers 9841, National Bureau of Economic Research, Inc.
  6. Obstfeld, Maurice & Taylor, Alan M., 2003. "Sovereign Risk, Credibility and the Gold Standard: 1870-1913 versus 1925-31," CEPR Discussion Papers 3688, C.E.P.R. Discussion Papers.
  7. Drazen, Allan & Masson, Paul R, 1994. "Credibility of Policies versus Credibility of Policymakers," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 735-54, August.
  8. David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers 560, Queen's University, Department of Economics.
  9. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-85, May.
  10. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," IDB Publications (Working Papers) 6467, Inter-American Development Bank.
  11. Mailath, George J & Samuelson, Larry, 2001. "Who Wants a Good Reputation?," Review of Economic Studies, Wiley Blackwell, vol. 68(2), pages 415-41, April.
  12. Michael D. Bordo & Marc Flandreau, 2001. "Core, Periphery, Exchange Rate Regimes, and Globalization," Sciences Po publications n°3077, Sciences Po.
  13. Alessandro Missale & Elisabetta Falcetti, . "Public Debt Indexation and Denomination with and Indipendent Central Bank," Working Papers 169, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  14. Bordo, Michael D. & Rockoff, Hugh, 1996. "The Gold Standard as a “Good Housekeeping Seal of Approval”," The Journal of Economic History, Cambridge University Press, vol. 56(02), pages 389-428, June.
  15. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers.
  16. Koppl, Roger & Yeager, Leland B., 1996. "Big Players and Herding in Asset Markets: The Case of the Russian Ruble," Explorations in Economic History, Elsevier, vol. 33(3), pages 367-383, July.
  17. Tirole, Jean, 1994. ""A Theory of Collective Reputations" with Applications to the Persistence of Corruption and to Firm Quality," IDEI Working Papers 38, Institut d'Économie Industrielle (IDEI), Toulouse.
  18. Gregory, Paul R., 1979. "The Russian Balance of Payments, the Gold Standard, and Monetary Policy: A Historical Example of Foreign Capital Movements," The Journal of Economic History, Cambridge University Press, vol. 39(02), pages 379-400, June.
  19. Flandreau, Marc & Sussman, Nathan, 2004. "Old Sins: Exchange Rate Clauses and European Foreign Lending in the 19th Century," CEPR Discussion Papers 4248, C.E.P.R. Discussion Papers.
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