Exchange Rates and Financial Fragility

Barry Eichengreen and Ricardo Hausmann

No 7418, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper we analyze three views of the relationship between the exchange rate and financial fragility: (1) the moral hazard hypothesis, according to which pegged exchange rates offer implicit insurance against exchange risk and thereby encourage reckless borrowing and lending; (2) the original sin hypothesis, which emphasizes an incompleteness in financial markets which prevents the domestic currency from being used to borrow abroad or to borrow long term even domestically; and (3) the commitment problem hypothesis, which sees financial crises as resulting from neither moral hazard nor original sin but from the weakness of the institutions that address commitment problems. We examine the evidence on these hypotheses and draw out their implications for exchange-rate policy in emerging markets.

JEL-codes: F3 G0 (search for similar items in EconPapers)
Date: 1999-11
New Economics Papers: this item is included in nep-ifn and nep-mon
Note: IFM
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Citations: View citations in EconPapers (771)

Published as Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.

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