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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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  9. Michael D. Bordo, 1995. "The Gold Standard as a `Good Housekeeping Seal of Approval'," NBER Working Papers 5340, National Bureau of Economic Research, Inc.
  10. Steve Tadelis, 1997. "What's in a Name? Reputation as a Tradeable Asset," Working Papers 97033, Stanford University, Department of Economics.
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  12. 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.
  13. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  14. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
  15. Falcetti, Elisabetta & Missale, Alessandro, 2002. "Public debt indexation and denomination with an independent central bank," European Economic Review, Elsevier, vol. 46(10), pages 1825-1850, December.
  16. 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.
  17. Olivier Jeanne, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," IMF Working Papers 03/177, International Monetary Fund.
  18. Grossman, Herschel I. & Van Huyck, John B., 1993. "Nominal sovereign debt, risk shifting, and reputation," Journal of Economics and Business, Elsevier, vol. 45(3-4), pages 341-352.
  19. 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.
  20. 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.
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