Deciding to Peg the Exchange Rate in Developing Countries: The Role of Private-Sector Debt

44 Pages Posted: 8 Jun 2016

See all articles by Philipp Harms

Philipp Harms

Johannes Gutenberg University Mainz

Mathias Hoffmann

Deutsche Bundesbank

Date Written: 2009

Abstract

We argue that a higher share of the private sector in a country's external debt raises the incentive to stabilize the exchange rate. We present a simple model in which exchange rate volatility does not affect agents' welfare if all the debt is incurred by the government. Once we introduce private banks who borrow in foreign currency and lend to domestic firms, the monetary authority has an incentive to dampen the distributional consequences of exchange rate fluctuations. Our empirical results support the hypothesis that not only the level, but also the composition of foreign debt matters for exchange-rate policy.

Keywords: Exchange rate regimes, foreign debt, monetary policy

JEL Classification: E52, F31, F41

Suggested Citation

Harms, Philipp and Hoffmann, Mathias, Deciding to Peg the Exchange Rate in Developing Countries: The Role of Private-Sector Debt (2009). Bundesbank Series 1 Discussion Paper No. 2009,34. Available at SSRN: https://ssrn.com/abstract=2785363

Philipp Harms (Contact Author)

Johannes Gutenberg University Mainz ( email )

Saarstrasse 21
Mainz, D-55099
Germany

Mathias Hoffmann

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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