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Debauchery and Original Sin: The Currency Composition of Sovereign Debt

JungJae Park and Charles Engel ()
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JungJae Park: National University of Singapore

No 1558, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: This paper quantitatively investigates the currency composition of sovereign debt in the presence of two types of limited enforcement frictions arising from a government’s monetary and debt policy: strategic currency debasement and default on sovereign debt. Local currency debt has better state contingency than foreign currency debt in the sense that its real value can be changed by a government’s monetary policy, thus acting as a better consumption hedge against income shocks. However, this higher degree of state contingency for local currency debt provides a government with more temptation to deviate from disciplined monetary policy, thus restricting borrowing in local currency more than in foreign currency. The two financial frictions related to the two limited enforcement problems combine to generate an endogenous debt frontier for local and foreign currency debts. Our model predicts that a less disciplined country in terms of monetary policy borrows mainly in foreign currency, as the country faces a much tighter borrowing limit for local currency debt than for the foreign currency debt. Our model accounts for the surge in local currency borrowings by emerging economies in the recent decade and “Mystery of Original Sin” by Eichengreen, Haussman, Panizza (2002)

New Economics Papers: this item is included in nep-dge, nep-opm and nep-sea
Date: 2017
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Working Paper: Debauchery and Original Sin: The Currency Composition of Sovereign Debt (2018) Downloads
Working Paper: Debauchery and Original Sin: The Currency Composition of Sovereign Debt (2018) Downloads
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