## Exchange Rate Policy and Debt Crises in Emerging Economies

_IMF Working Papers, March 1, 2003_

## Source details

**Canonical URL:** [Exchange Rate Policy and Debt Crises in Emerging Economies](https://www.imf.org/en/publications/wp/issues/2016/12/30/exchange-rate-policy-and-debt-crises-in-emerging-economies-16382)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/30/exchange-rate-policy-and-debt-crises-in-emerging-economies-16382/index.md)
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## Bibliographic details
- Authors: Peter J Montiel, Samir Jahjah
- Published: March 1, 2003
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451848076.001

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### Summary findings
- The model captures interaction between exchange rate policy, fiscal policy, and outright default on foreign-currency denominated debt.
- Under a credible hard peg (currency board), default is a more likely outcome even without an exceptionally large short-term debt, because devaluation is not an option.
- Under a conventional fixed peg, the government may optimally choose an exchange rate level that is likely to result in partial or complete debt default.
- Depending on the exchange rate regime, multiple equilibria can exist; one equilibrium features:
  - high interest rate,
  - overvalued exchange rate,
  - low output,
  - high default.
- Under a hard peg, there is a unique equilibrium.

### Model mechanisms and channels
- The exchange rate affects the supply of short-term debt facing the government.
- Credible hard peg removes devaluation as a policy option, altering default incentives.
- Fixed peg regimes allow the government discretion over the exchange rate level, potentially inducing policies that increase default likelihood.

### Scenarios and equilibria
- Multiple equilibria under certain exchange rate regimes:
  - Equilibrium A (adverse): high interest rate; exchange rate overvaluation; low output; high default.
  - Equilibrium B (more favorable): not described in detail in the summary, but implied to contrast with Equilibrium A.
- Unique equilibrium under a credible hard peg characterized by the absence of multiple self-fulfilling outcomes.

### Policy implications
- Exchange rate regime choice materially affects government default risk on foreign-currency debt.
- Hard pegs (currency boards) can increase default probability by eliminating devaluation as an adjustment mechanism.
- Under fixed pegs, governments may set exchange rates that trade off exchange rate stability against higher default risk; policymakers should consider this trade-off when designing exchange rate and fiscal policies.

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## Content in this bundle

- **Exchange Rate Policy and Debt Crises in Emerging Economies - WP/03/60, corrected**
  - [Exchange Rate Policy and Debt Crises in Emerging Economies - WP/03/60, corrected (Markdown version)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp0360.pdf.md){rel="alternate" type="text/markdown"}
  - [Exchange Rate Policy and Debt Crises in Emerging Economies - WP/03/60, corrected (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp0360.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/exchange-rate-policy-and-debt-crises-in-emerging-economies-16382_