High Public Debt in Currency Crises: Fundamentals Versus Signalling Effects

34 Pages Posted: 24 Jul 2001

See all articles by Pierpaolo Benigno

Pierpaolo Benigno

University of Bern - Department of Economics; Einaudi Institute for Economics and Finance (EIEF)

Alessandro Missale

University of Milan - Department of Business Policy and Economics

Date Written: July 2001

Abstract

This Paper examines how public debt, government credibility and external circumstances affect the probability of exchange rate devaluations in a three-period open-economy version of the Barro-Gordon (1983) model with nominal public debt. Public debt creates a link between current and future policy actions: resisting a crisis may enhance or undermine the sustainability of the exchange-rate regime depending on whether the government's reputation or fundamentals - i.e. the level of public debt - are critical for sustainability. The focus is on the impact of public debt, debt maturity and government credibility on the expected devaluation for the current and future periods. This allows us to identify factors affecting the short-term interest rate and the forward rate and hence to derive predictions on the level and the slope of the term structure of interest rates.

Keywords: Credibility, nominal debt maturity, fixed exchange rates, yield curve

JEL Classification: E58, F31, F33, H63

Suggested Citation

Benigno, Pierpaolo and Missale, Alessandro, High Public Debt in Currency Crises: Fundamentals Versus Signalling Effects (July 2001). Available at SSRN: https://ssrn.com/abstract=277148

Pierpaolo Benigno (Contact Author)

University of Bern - Department of Economics ( email )

Schanzeneckstrasse 1
Bern, CH-3001
Switzerland

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Alessandro Missale

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

Via Conservatorio 7
I-20122 Milano
Italy

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