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Foreign Debt and Fear of Floating: A Theoretical Exploration

  • Michael Bleaney
  • F. Gulcin Ozkan

This paper explores the relationship between the denomination of public debt and the choice of exchange rate regime. Unlike indexed domestic debt, foreign debt is subject to valuation effects from real exchange rate shocks. In a standard set-up, where a peg functions only as a nominal anchor, more foreign debt makes pegging less attractive, because it increases the value of a flexible exchange rate as a shock absorber. This result can be reversed if we incorporate the stylized fact that pegs have lower real exchange rate volatility, and if external shocks are sufficiently large relative to domestic shocks.

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File URL: http://www.nottingham.ac.uk/economics/documents/discussion-papers/08-03.pdf
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Paper provided by University of Nottingham, School of Economics in its series Discussion Papers with number 08/03.

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Handle: RePEc:not:notecp:08/03
Contact details of provider: Postal: School of Economics University of Nottingham University Park Nottingham NG7 2RD
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Web page: http://www.nottingham.ac.uk/economics/

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  1. Beetsma, Roel M. W. J. & Bovenberg, A. Lans, 1997. "Central bank independence and public debt policy," Journal of Economic Dynamics and Control, Elsevier, vol. 21(4-5), pages 873-894, May.
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  3. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  4. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  5. Flood, Robert P. & Rose, Andrew K., 1995. "Fixing exchange rates A virtual quest for fundamentals," Journal of Monetary Economics, Elsevier, vol. 36(1), pages 3-37, August.
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  7. Beetsma, Roel & Bovenberg, A Lans, 1995. "Does Monetary Unification Lead to Excessive Debt Accumulation?," CEPR Discussion Papers 1299, C.E.P.R. Discussion Papers.
  8. Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January.
  9. Frankel, Jeffrey, 2005. "Contractionary Currency Crashes In Developing Countries," Working Paper Series rwp05-017, Harvard University, John F. Kennedy School of Government.
  10. repec:ner:tilbur:urn:nbn:nl:ui:12-74443 is not listed on IDEAS
  11. Cook, David, 2004. "Monetary policy in emerging markets: Can liability dollarization explain contractionary devaluations?," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1155-1181, September.
  12. Marianne Baxter & Alan C. Stockman, 1988. "Business Cycles and the Exchange Rate System: Some International Evidence," NBER Working Papers 2689, National Bureau of Economic Research, Inc.
  13. Bovenberg, A.L. & Beetsma, R.M.W.J., 1997. "Central Bank independence and public debt policy," Other publications TiSEM d1fc1375-507c-445b-9b38-d, Tilburg University, School of Economics and Management.
  14. Helge Berger & Henrik Jensen & Guttorm Schjelderup, 2001. "To Peg or Not To Peg? A Simple Model of Exchange Rate Regime Choice In Small Economies," CESifo Working Paper Series 468, CESifo Group Munich.
  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. 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.
  17. Honig, Adam, 2005. "Fear of floating and domestic liability dollarization," Emerging Markets Review, Elsevier, vol. 6(3), pages 289-307, September.
  18. Gupta, Poonam & Mishra, Deepak & Sahay, Ratna, 2007. "Behavior of output during currency crises," Journal of International Economics, Elsevier, vol. 72(2), pages 428-450, July.
  19. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  20. Michael Bleaney & Manuela Francisco, 2008. "Balance sheet effects and the choice of exchange rate regime in developing countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 17(2), pages 297-310.
  21. Michael D. Bordo, 2003. "Exchange Rate Regime Choice in Historical Perspective," NBER Working Papers 9654, National Bureau of Economic Research, Inc.
  22. Ozkan, F Gulcin, 2000. " Who Wants an Independent Central Bank? Monetary Policy-Making and Politics," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(4), pages 621-43, December.
  23. Hasan, Shahriar & Wallace, Myles, 1996. "Real exchange rate volatility and exchange rate regimes: Evidence from long-term data," Economics Letters, Elsevier, vol. 52(1), pages 67-73, July.
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