130 Years of Fiscal Vulnerabilities and Currency Crashes in Advanced Economies

55 Pages Posted: 1 Nov 2011

See all articles by Marcel Fratzscher

Marcel Fratzscher

DIW Berlin; Centre for Economic Policy Research (CEPR)

Arnaud Mehl

European Central Bank (ECB)

Isabel Vansteenkiste

European Central Bank (ECB)

Date Written: October 2011

Abstract

This paper investigates the empirical link between fiscal vulnerabilities and currency crashes in advanced economies over the last 130 years, building on a new dataset of real effective exchange rates and fiscal balances for 21 countries since 1880. We find evidence that crashes depend more on prospective fiscal deficits than on actual ones, and more on the composition of public debt (i.e. rollover/sudden stop risk) than on its level per se. We also uncover significant nonlinear effects at high levels of public debt as well as significantly negative risk premia for major reserve currencies, which enjoy a lower probability of currency crash than other currencies ceteris paribus. Yet, our estimates indicate that such premia remain small in size relative to the conditional probability of a currency crash if prospective fiscal deficits or rollover/sudden stop risk are high. This suggests that a currency’s international status is not necessarily sufficient to shelter it from collapse.

Keywords: advanced economies, banking crises, currency crashes, exchange rates, fiscal vulnerability, foreign debt, reserve currencies, total debt level

JEL Classification: F30, F31, N20

Suggested Citation

Fratzscher, Marcel and Mehl, Arnaud and Vansteenkiste, Isabel, 130 Years of Fiscal Vulnerabilities and Currency Crashes in Advanced Economies (October 2011). CEPR Discussion Paper No. DP8612. Available at SSRN: https://ssrn.com/abstract=1952477

Marcel Fratzscher (Contact Author)

DIW Berlin ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Arnaud Mehl

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Isabel Vansteenkiste

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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