Credibility, Public Debt and Foreign Exchange Intervention
McGill Finance Research Centre Working Paper
38 Pages Posted: 18 Sep 2001
Date Written: July 20, 2001
This paper presents a generalized framework where a discretionary government finds it ex-post optimal to create a downward bias in the exchange rate in addition to the inflation bias of Barro-Gordon type. This dual credibility model helps explain the empirical pattern of public debt financing most recently reported by Falcetti and Missale (2000). Most notably, large and developed economies are predicted to have lower inflation and more conventional home currency bonds. The small and emerging economies, on the other hand, are expected to have relatively higher inflation and more foreign currency bonds. This suggests that a judicious use of a portfolio of home and foreign currency bonds may help economies that are in transition to independent central banking.
Keywords: credibility, public debt, foreign exchange intervention
JEL Classification: E52, E58, F41, H63
Suggested Citation: Suggested Citation