Exchange Rate Policy and Debt Crises in Emerging Economies

Peter Montiel and Samir Jahjah

No 2003/060, IMF Working Papers from International Monetary Fund

Abstract: We explore a model intended to capture the interaction between exchange rate policy, fiscal policy, and outright default on foreign-currency denominated debt. We examine how the exchange rate affects the supply of short-term debt facing the government. We show that under a credible hard peg (currency board), default is a more likely outcome, even without an exceptionally large short-term debt, precisely because a devaluation is not an option. In a more conventional fixed peg, it can be optimal for the government to choose a level of the exchange rate that would be likely to result in partial or complete debt default. Depending on the exchange rate regime, multiple equilibria exist, in one of which the interest rate is high, the exchange rate is overvalued, output is low, and default is high. Under a hard peg, there is a unique equilibrium.

Keywords: WP; short-term debt; debt service; fiscal policy; interest rate; Debt crises; exchange rate policy; default; devaluation; default rate; supply curve; exchange rate depreciation; exchange rate misalignment; foreign currency; debt repudiation; long-term debt; exchange rate response curve; exchange rate overvaluation; government default; exchange rate peg; Exchange rates; Real exchange rates; Debt default; Exchange rate adjustments (search for similar items in EconPapers)
Pages: 22
Date: 2003-03-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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