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Foreign Debt and Fear of Floating: A Theoretical Exploration

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  • Michael Bleaney
  • F. Gulcin Ozkan

Abstract

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 fexible 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.

Suggested Citation

  • Michael Bleaney & F. Gulcin Ozkan, 2008. "Foreign Debt and Fear of Floating: A Theoretical Exploration," Discussion Papers 08/10, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:08/10
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    References listed on IDEAS

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    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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