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The structure of public debt and the choice of exchange rate regime

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  • Michael Bleaney
  • F. Gulcin Ozkan
Abstract
This paper explores the relationship between the denomination of public debt and the choice of exchange rate regime. Three types of debt (nominal, indexed, and foreign) and two regimes (fixed and flexible) are considered. Indexed debt is insulated against unexpected inflation. The real (domestic‐currency) value of foreign debt is subject to valuation effects from real exchange rate shocks. The ‘fear‐of‐floating’ result, that foreign debt makes pegging more attractive, is shown to hold unambiguously only if the peg is fully credible. If the peg lacks credibility, a critical factor is the perceived likelihood of using the ‘escape clause’ of a switch to a float, which raises the costs of pegging. Foreign debt increases the temptation to resort to the escape clause, so when a peg is not fully credible (as is almost always the case in reality), pegging tends to be less attractive than floating in the presence of foreign debt. Ce mémoire explore le rapport entre la dénomination de la dette publique et le choix d'un régime de taux de change. Trois types de dettes sont considérées (nominale, indexée, étrangère), et deux types de régimes (taux fixes et taux flexibles). La dette indexée est immunisée contre l'inflation imprévue. La valeur réelle (en monnaie domestique) de la dette étrangère est sujette à des effets attribuables aux chocs dans les taux de change réels. La ≪peur de laisser flotter le taux de change≫ aide à comprendre qu'une dette étrangère rend le taux fixe plus attrayant, mais ce résultat est sans ambiguïté seulement si le taux fixé est pleinement crédible. Si le taux fixé manque de crédibilité, un facteur critique est la perception de la probabilité qu'on va utiliser ≪l'échappatoire≫ du passage au taux flottant, ce qui augmente les cots d'un taux fixe. La dette étrangère accroît la tentation d'avoir recours à la ≪clause échappatoire≫, ce qui fait que quand un taux fixé n'est pas pleinement crédible, (comme c'est à peu près toujours le cas en réalité), un régime de taux de change fixe tend à tre moins attrayant qu'un régime de taux de change flottants quand il y a dette étrangère.

Suggested Citation

  • Michael Bleaney & F. Gulcin Ozkan, 2011. "The structure of public debt and the choice of exchange rate regime," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 44(1), pages 325-339, February.
    • Handle: RePEc:wly:canjec:v:44:y:2011:i:1:p:325-339
    DOI: 10.1111/j.1540-5982.2010.01634.x
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    Cited by:

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    2. Carl Grekou, 2015. "Currency misalignments and economic growth: the foreign currency-denominated debt channel," EconomiX Working Papers 2015-23, University of Paris Nanterre, EconomiX.
    3. Eiji Fujii, 2024. "Currency concentration in sovereign debt, exchange rate cyclicality, and volatility in consumption," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 160(1), pages 169-192, February.
    4. Eiji Fujii, 2020. "Currency Portfolio of External Debt, Exchange Rate Cyclicality, and Consumption Volatility," CESifo Working Paper Series 8287, CESifo.
    5. Fisera, Boris & Workie Tiruneh, Menbere & Hojdan, David, 2021. "Currency depreciations in emerging economies: A blessing or a curse for external debt management?," International Economics, Elsevier, vol. 168(C), pages 132-165.
    6. Mohamed Bouabidi, 2023. "The surge in Tunisia foreign debt: causes and possible ways out," SN Business & Economics, Springer, vol. 3(3), pages 1-23, March.
    7. Christine Olivia Strong, 2023. "The impact of fiscal rules on government debt: evidence from the CFA zone," Empirical Economics, Springer, vol. 65(5), pages 2357-2391, November.
    8. Mohamed Bouabidi, 2022. "The Tunisian exchange rate regime: Is it really floating?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(4), pages 4684-4704, October.

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    More about this item

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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