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Corruption Clubs: The Allocation of Public Expenditure and Economic Growth

  • S Jahjah
  • P Montiel
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    Motivated by the experiences of Mexico and Argentina, we explore a model intended to capture the interactions among exchange rate policy, fiscal policy, and default on foreign currency-denominated debt. Our objective is to examine how exchange rate policy affects the supply of short-term debt facing the government. We show that under a conventional soft peg, it can be optimal for the government to choose a level of the exchange rate that may result in partial or complete debt default, as in the Mexican case. Paradoxically, default may also be an equilibrium outcome under a hard peg, as in the case of Argentina, precisely because devaluation is not an option. Multiple equilibria may exist under a soft peg, with one equilibrium featuring a high domestic interest rate, an overvalued exchange rate, a low level of output, and a high default probability. Under a hard peg, however, there is a unique equilibrium.

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    File URL: http://www.socialsciences.manchester.ac.uk/medialibrary/cgbcr/discussionpapers/dpcgbcr70.pdf
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    Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 70.

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    Length: 88 pages
    Date of creation: 2006
    Date of revision:
    Handle: RePEc:man:cgbcrp:70
    Contact details of provider: Postal: Manchester M13 9PL
    Phone: (0)161 275 4868
    Fax: (0)161 275 4812
    Web page: http://www.socialsciences.manchester.ac.uk/subjects/economics/our-research/centre-for-growth-and-business-cycle-research/

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    1. Eichengreen, Barry, 1990. "Historical Research on International Lending and Debt," Department of Economics, Working Paper Series qt39n6n9ns, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    2. Rudiger Dornbusch & Alejandro Werner, 1994. "Mexico: Stabilization, Reform, and No Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(1), pages 253-316.
    3. Edwards, Sebastian, 1984. "LDC Foreign Borrowing and Default Risk: An Empirical Investigation, 1976-80," American Economic Review, American Economic Association, vol. 74(4), pages 726-34, September.
    4. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
    5. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
    6. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-97, December.
    7. Reinhart, Carmen, 2002. "Default, currency crises, and sovereign credit ratings," MPRA Paper 13917, University Library of Munich, Germany.
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