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On the Fiscal Implications of Twin Crises

This paper explores the implications of different strategies for financng the fiscal costs of twin crises for inflation and depreciation rates. We use a first-generation type model of speculative attacks which has four key features: (i) the crisis is triggered by prospective deficits; (ii) there exists outstanding non-indexed government debt issued prior to the crisis; (iii) a portion of the government's liabilities are not indexed to inflation; (iv) there are nontradeable goods and costs of distributing tradeable goods, so that the purchasing power parity does not hold. We show that the model can account for the high rates of devaluation and the moderate rates of inflation often observed in the wake of currency crises. We use our model and the data to interpret the recent currency crises in mexico and Korea. Our analysis suggests that the Mexican government is likely to pay for the bulk of the fiscal costs of its crisis through seignorage revenues. in contrast, the Korean government is likely to rely more on a combination of implicit and explicit fiscal reforms.

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File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_482.pdf
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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 482.

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Length: 40 pages
Date of creation: May 2001
Date of revision:
Handle: RePEc:roc:rocher:482
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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  1. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 1999. "Prospective deficits and the asian currency crisis," Policy Research Working Paper Series 2174, The World Bank.
  2. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-72, January.
  3. Menzie D. Chinn & Kenneth M. Kletzer, 2000. "International Capital Inflows, Domestic Financial Intermediation and Financial Crises under Imperfect Information," NBER Working Papers 7902, National Bureau of Economic Research, Inc.
  4. Buiter, Willem H., 1987. "Borrowing to defend the exchange rate and the timing and magnitude of speculative attacks," Journal of International Economics, Elsevier, vol. 23(3-4), pages 221-239, November.
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