Nominal Debt and the Dynamics of Currency Crises

30 Pages Posted: 29 Aug 2001

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

European University Institute; University of Cambridge; Centre for Economic Policy Research (CEPR)

Bartosz Mackowiak

Humboldt University of Berlin - Faculty of Economics

Date Written: August 2001

Abstract

This Paper proposes a new framework for interpreting a currency crisis associated with a fiscal imbalance, that we find appropriate for the analysis of contemporary economies with outstanding public debt. Unlike the first-generation literature on speculative attacks, we do not assume that money growth finances the imbalance and that governments face exogenous borrowing constraints. In our model, the cause of a devaluation is a fiscal policy switch, from a policy backing government debt fully with taxes, to one using taxes and unanticipated inflation. Its timing depends on the interaction of fiscal and monetary policy, where the latter is modeled in terms of interest rate rules. Real debt acts as leverage, and the rate of devaluation is smaller when nominal liabilities are a larger fraction of the total. The focus of our analysis of currency crises is on currency of denomination and maturity of government debt; the government's willingness to tolerate high interest rates; the possibility of coordination problems among holders of government debt.

Keywords: Currency crisis, speculative attack, fiscal theory of the price level

JEL Classification: E58, F31, F33

Suggested Citation

Corsetti, Giancarlo and Mackowiak, Bartosz, Nominal Debt and the Dynamics of Currency Crises (August 2001). Available at SSRN: https://ssrn.com/abstract=281674

Giancarlo Corsetti (Contact Author)

European University Institute ( email )

University of Cambridge ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Bartosz Mackowiak

Humboldt University of Berlin - Faculty of Economics ( email )

Spandauer Strasse 1
Berlin
Germany

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