Working Paper: NBER ID: w1844
Authors: Willem H. Buiter
Abstract: The paper extends the recent literature on collapsing managed exchange rate regimes by allowing explicitly for the qovernment budget constraint and the interest cost of servicing the public debt. The policy experivent that is analysed is the decision by a government to replenish its stock of foreign exchange reserve through a once-off open market sale of bonds. Without a fundanental fiscal correction (i.e. a decision to reduce the primary (non-interest) deficit by an amount equal to the increase in the interest cost of servicing the debt) the conseqinces are as follows. In a deterministic model the timing of the speculative attack is brought forward (delayed) if the borrowing takes place long before (close to) the date at which without borrowing the collapse would have occurred. The magnitude of the attack (the final loss of reserves) always increases because of borrowing. In a stochastic model, borrowing reduces the probability of an early collapse and increases the likelihood of a later collapse. Under mild conditions, the expected length of the time interval until the collapse occus is increased by borrowing.
Keywords: exchange rate; speculative attacks; government borrowing; fiscal policy
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government borrowing (H74) | Timing of speculative attack (D84) |
| Timing of borrowing (G51) | Timing of speculative attack (D84) |
| Government borrowing (H74) | Probability of early collapse (G33) |
| Government borrowing (H74) | Probability of later collapse (G33) |
| Government borrowing (H74) | Magnitude of speculative attack (D84) |
| Interest costs of servicing debt (G32) | Dynamics of domestic credit expansion (E51) |
| Dynamics of domestic credit expansion (E51) | Stock of reserves (Q31) |