Working Paper: NBER ID: w2702
Authors: Linda S. Goldberg
Abstract: Patterns in domestic credit creation stemming from inconsistent fiscal policies have received widespread attention for aggravating speculative attacks on central bank foreign exchange reserves and contributing to the collapse of exchange rate regimes. This paper acknowledges the importance of monetary and fiscal discipline, but also emphasizes the importance of other random shocks to the domestic money market, most notably shocks from external credit supplies and relative prices. Policies of the domestic fiscal authorities are only partial catalysts for speculative attacks on a currency. Expansion of domestic credit stemming from the monetization of fiscal imbalances may be dominated by involuntary domestic credit expansions necessitated by surprise shortages in supplies of external capital. Further, the unexpected availability of external capital translates into a lower net critical reserve floor, making the depletion of central bank reserves by a speculative attack more difficult to accomplish. Also of considerable importance are relative price shocks which directly influence the probability of collapse by randomizing the demand for nominal money balances. Empirical studies of exchange rate crises that neglect these considerations will produce biased estimates of both expected collapse probabilities and anticipated post-collapse exchange rates.
Keywords: exchange rate regimes; speculative attacks; domestic credit creation; fiscal policies
JEL Codes: F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Inconsistent fiscal policies (E62) | Domestic Credit Creation (E51) |
| External Shocks (F41) | Net Critical Reserve Floor (G19) |
| Net Critical Reserve Floor (G19) | Depletion of Central Bank Reserves (E58) |
| Relative Price Shocks (E30) | Demand for Nominal Money Balances (E41) |
| Demand for Nominal Money Balances (E41) | Probability of Collapse (G33) |
| Neglecting Factors (C29) | Biased Estimates (C51) |
| Domestic Credit Creation (E51) | Speculative Attacks (D84) |