Fiscal Dominance, Debt, and Exchange Rates

32 Pages Posted: 15 Feb 2006

Date Written: August 17, 1987

Abstract

Fiscally weak governments may prefer to reduce through devaluation the real value of their domestic financial obligations, rather than adjusting the fiscal deficit in order to keep servicing their debt. If the public anticipates this possibility, within a flexible exchange rate system, lose fiscal policies provoke exchange rate depreciations, while efforts to bring the deficit under control have the opposite effect. This interpretation contrasts with conventional views on the impact of fiscal expansions. The paper applies this "fiscal approach" to exchange rates to two alternative models of exchange rate dynamics in a small open economy, and analyzes some policy implications.

JEL Classification: 4312, 3200

Suggested Citation

Ize, Alain, Fiscal Dominance, Debt, and Exchange Rates (August 17, 1987). IMF Working Paper No. 87/52, Available at SSRN: https://ssrn.com/abstract=884829

Alain Ize (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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