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Foreign Debt and Fear of Floating: A Theoretical Exploration

Listed author(s):
  • 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
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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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  2. Beetsma, Roel M. W. J. & Bovenberg, A. Lans, 1999. "Does monetary unification lead to excessive debt accumulation?," Journal of Public Economics, Elsevier, vol. 74(3), pages 299-325, December.
  3. 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.
  4. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 379-408.
  5. 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.
  6. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 1-48.
  7. 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.
  8. 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.
  9. 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 621-643, December.
  10. 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.
  11. Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2004. "Balance Sheets and Exchange Rate Policy," American Economic Review, American Economic Association, vol. 94(4), pages 1183-1193, September.
  12. 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.
  13. Berger, Helge & Jensen, Henrik & Schjelderup, Guttorm, 2001. "To peg or not to peg?: A simple model of exchange rate regime choice in small economies," Economics Letters, Elsevier, vol. 73(2), pages 161-167, November.
  14. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters,in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  15. 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.
  16. Jeffrey Frankel, 2005. "Contractionary Currency Crashes In Developing Countries," CID Working Papers 117, Center for International Development at Harvard University.
  17. Michael D. Bordo, 2003. "Exchange Rate Regime Choice in Historical Perspective," IMF Working Papers 03/160, International Monetary Fund.
  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. 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.
  20. 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.
  21. Honig, Adam, 2005. "Fear of floating and domestic liability dollarization," Emerging Markets Review, Elsevier, vol. 6(3), pages 289-307, September.
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