Exchange Rate Policy and Debt Crises in Emerging Economies

22 Pages Posted: 28 Jan 2006

See all articles by Samir Jahjah

Samir Jahjah

International Monetary Fund - INS

Peter J. Montiel

Williams College - Department of Economics

Date Written: March 2003

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: Debt crises, exchange rate policy, default, devaluation

JEL Classification: E58, E62, F33, F34

Suggested Citation

Jahjah, Samir and Montiel, Peter J., Exchange Rate Policy and Debt Crises in Emerging Economies (March 2003). IMF Working Paper No. 03/60, Available at SSRN: https://ssrn.com/abstract=879135

Samir Jahjah (Contact Author)

International Monetary Fund - INS ( email )

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Peter J. Montiel

Williams College - Department of Economics ( email )

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HOME PAGE: http://www.williams.edu/Economics/faculty/montiel.htm

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