The Currency Denomination of Public Debt and the Choice of the Monetary Regime

LSE-CEP Discussion Paper No. 427

33 Pages Posted: 11 Aug 1999

See all articles by Elisabetta Falcetti

Elisabetta Falcetti

European Bank for Reconstruction and Development (EBRD)

Alessandro Missale

University of Milan - Department of Business Policy and Economics

Date Written: June 1999

Abstract

This paper examines the interactions between monetary regimes and public debt management. The analysis shows that delegation of monetary policy to an independent central bank is more effective in containing inflationary expectations than the use of foreign currency or price-indexed debt. If delegation of monetary policy is viable, the optimal policy is to issue conventional debt so as to reduce the cost of supply shocks and thus the need for policy accommodation. The role of debt management changes in a fixed exchange regime, since foreign currency debt may enhance the credibility of the peg. However, if a crisis nevertheless materializes, it would be worse than had foreign debt not been issued. Empirical evidence on the EMS appears to support this result. Probit estimates show that the decision to issue foreign currency debt significantly reduced the likelihood of an official realignment within the ERM. However, conditional on a crisis taking place, those countries that increased the share of foreign currency debt experienced larger devaluation sizes.

JEL Classification: E58, H63, F31, F33

Suggested Citation

Falcetti, Elisabetta and Missale, Alessandro, The Currency Denomination of Public Debt and the Choice of the Monetary Regime (June 1999). LSE-CEP Discussion Paper No. 427, Available at SSRN: https://ssrn.com/abstract=169068 or http://dx.doi.org/10.2139/ssrn.169068

Elisabetta Falcetti

European Bank for Reconstruction and Development (EBRD) ( email )

One Exchange Square
London, EC2A 2EH
United Kingdom

Alessandro Missale (Contact Author)

University of Milan - Department of Business Policy and Economics ( email )

Via Conservatorio 7
I-20122 Milano
Italy

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