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Exchange Rate Crises and Fiscal Solvency

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  • BETTY C. DANIEL

Abstract

This paper combines insights from generation one currency crisis models and the fiscal theory of the price level (FTPL) to create a dynamic FTPL model of currency crises. The initial fixed‐exchange‐rate policy entails risks due to an upper bound on government debt and stochastic surplus shocks. Agents refuse to lend into a position for which the value of debt exceeds the present value of expected future surpluses. Policy switching, usually combined with currency depreciation, restores fiscal solvency and lending. This model can explain a wide variety of crises, including those involving sovereign default. We illustrate by explaining the crisis in Argentina (2001).

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  • Betty C. Daniel, 2010. "Exchange Rate Crises and Fiscal Solvency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1109-1135, September.
    • Handle: RePEc:wly:jmoncb:v:42:y:2010:i:6:p:1109-1135
    DOI: 10.1111/j.1538-4616.2010.00322.x
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