TABLE OF CONTENTS
Acknowledgments
Introduction - Barry Eichengreen, Ricardo Hausmann
DOI: 10.7208/chicago/9780226194578.003.0001
[foreign debt, foreign currency, original sin, emerging markets, external debt, United States, bonds, sovereign debt, gold clauses, currency denomination]
This book provides new information on the extent to which foreign debt is denominated in foreign currency; that is, it attempts to measure the incidence of original sin. It analyzes the consequences of original sin for the economic performance and prospects of emerging markets. It investigates the underlying sources of the problem. The book proposes an international initiative to ameliorate it. Each goal is pursued with both theory and empirical analysis. The book also attempts to measure original sin and analyze its consequences and explores the channels through which macroeconomic outcomes are affected by the currency denomination of the external debt. The United States government was able to issue and market dollar-denominated bonds abroad from the beginning of the nineteenth century, although the amounts involved were small and U.S. sovereign debt had gold clauses (effectively indexing it to foreign currency) until 1933. (pages 3 - 12)
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The Pain of Original Sin - Barry Eichengreen, Ricardo Hausmann, Ugo Panizza
DOI: 10.7208/chicago/9780226194578.003.0002
[external debt, foreign currency, capital flows, exchange rates, credit ratings, original sin, macroeconomic policies]
This chapter shows that the composition of external debt—and specifically the extent to which that debt is denominated in foreign currency—is a key determinant of the stability of output, the volatility of capital flows, the management of exchange rates, and the level of country credit ratings. It presents empirical analysis demonstrating that this “original sin” problem has statistically significant and economically important implications, even after controlling for other conventional determinants of macroeconomic outcomes. The chapter shows that the macroeconomic policies on which growth and cyclical stability depend, according to conventional wisdom, are themselves importantly shaped by the denomination of countries' external debts. Establishing the importance of original sin for the macroeconomic outcomes of interest requires a precise measure of the phenomenon. (pages 13 - 47)
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Must Original Sin Cause Macroeconomic Damnation? - Luis Felipe Céspedes, Roberto Chang, AndrCés Velasco
DOI: 10.7208/chicago/9780226194578.003.0003
[exchange rates, domestic currency, risk premium, schedules, original sin, balance-sheet effects, liability dollarization, wages, prices, open-economy model]
This chapter develops a simple general equilibrium open-economy model in which real exchange rates play a central role in the adjustment process, wages and prices are sticky in terms of domestic currency, liabilities are dollarized, and the country risk premium is endogenously determined by the net worth of domestic entrepreneurs. Hence, all the basic building blocks are there for unexpected real exchange rate movements to be financially dangerous under original sin. In spite of the model's apparent complexity, it obtains an analytic solution for all variables of interest, which can be depicted in terms of three familiar schedules: the IS and the LM, which correspond to equilibrium conditions in the goods and money market, and the BP, along which the international loan market is in equilibrium. This characterization helps to identify exactly how the combination of balance-sheet effects and liability dollarization may lead to departures from the standard framework. (pages 48 - 66)
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A Fiscal Perspective on Currency Crises and Original Sin - Giancarlo Corsetti, Bartosz Maćkowiak
DOI: 10.7208/chicago/9780226194578.003.0004
[synthetic model, denomination, public debt, Paul Krugman, Robert Flood, Peter Garber, interest rate rule, seigniorage revenues, open-economy model]
This chapter provides an exposition of the synthetic model, highlighting how it enhances one's understanding of the effects of denomination and maturity of public debt more generally. The starting point is the experiment of Paul Krugman, Robert Flood, and Peter Garber in an economy with a fixed exchange rate and public debt (domestic- and foreign-currency, short- and long-term). The chapter postulates an exogenous disturbance that decreases the present value of government's real primary surpluses relative to its outstanding liabilities. It analyzes the dynamics of adjustment and models fiscal policy as non-Ricardian and monetary policy as pursuing an interest rate rule. The chapter summarizes the insights from the synthetic model: insufficient fiscal discipline can undermine currency stability independently of any need for seigniorage revenues. The chapter contributes a simple illustration of this point in the context of a small open-economy model with money introduced in a standard way. (pages 68 - 94)
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Original Sin, Balance-Sheet Crises, and the Roles of International Lending - Olivier Jeanne, Jeromin Zettelmeyer
DOI: 10.7208/chicago/9780226194578.003.0005
[international lending, balance-sheet approach, financial crises, foreign-currency debt, domestic policies]
This chapter explains the role of international lending in the context of the “balance-sheet approach” to financial crises. The general consensus that foreign-currency debt is problematic masks a surprising variety of opinions and models of the dangers involved. Rather than presenting one more model of the dangers of foreign-currency debt, the chapter presents a framework that is general and flexible enough to organize a discussion of the recent literature, in a way that is not dependent on modeling details. The first part of the chapter can be viewed as a brief tour of the literature for the practitioner. In the second part, it discusses some of the challenges for domestic policies that arise in this framework, and the potential roles for international crisis lending. (pages 95 - 121)
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How Original Sin Was Overcome - Michael D. Bordo, Christopher M. Meissner, Angela Redish
DOI: 10.7208/chicago/9780226194578.003.0006
[original sin, Great Britain, United States, Canada, Australia, New Zealand, South Africa, domestic debt, currency, gold clauses]
This chapter presents an historical case study for a group of countries that successfully entered the club and had largely overcome the problem of original sin by the third quarter of the twentieth century. The group consists of several former colonies of Great Britain: the United States, Canada, Australia, New Zealand, and South Africa. The chapter traces out their debt history, relating the currency to the place of issue, exploring the residency of those holding local- and foreign-currency debt, and looking at the maturity of domestic debt in the nineteenth and twentieth centuries. U.S. sovereign debt had implicit or explicit gold clauses until 1933. States and corporations borrowed completely in dollars only by the late nineteenth century and always did so with gold clauses until the gold standard was finally abandoned. (pages 122 - 153)
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Old Sins Exchange Clauses and European Foreign Lending In the Nineteenth Century - Marc Flandreau, Nathan Sussman
DOI: 10.7208/chicago/9780226194578.003.0007
[original sin, Argentina, Brazil, exchange crisis, depreciation, currency, expectations, institutions, defaults, exchange rate]
One popular explanation for original sin emphasizes expectations. Some countries do not have a sufficient record to borrow in their own currency. The market would then ration them, or would dictate terms that would deter them from borrowing in their own currency. From a policy point of view, the response to these problems would be to establish credibility by creating institutions: an independent central bank, the rule of law, and protection of property rights would be what is needed to establish a record that would in turn enable borrowing in one's own currency. This chapter challenges this popular, “expectations driven” interpretation of original sin. The 1890s crises in Argentina, Brazil, and Portugal all began with an exchange crisis that triggered a default or near default through the governments' liability exposure to exchange depreciation. Like today, a number of emerging nations had borrowed in gold or set a fixed exchange rate for the coupon, which led to defaults. (pages 154 - 189)
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Why Do Emerging Economies Borrow in Foreign Currency? - Olivier Jeanne
DOI: 10.7208/chicago/9780226194578.003.0008
[borrowers, long-term debt, domestic currency, original sin, monetary policy, foreign currency, debt, fixed currency, devaluation]
This chapter addresses the following question: Why is it that emerging-market borrowers find it more difficult or less desirable to issue long-term debt denominated in domestic currency? To put it succinctly, the hypothesis proposed in this chapter is that “original sin” is the result of the lack of credibility in domestic monetary policy. Unpredictable monetary policy makes borrowers unsure about the future real value of their domestic-currency debts, and may induce them to dollarize their liabilities. This is so even though foreign currency debt is itself dangerous, especially in the event of a large depreciation. The chapter illustrates this point with a model of a fixed currency peg in which increasing the probability of devaluation induces domestic firms to borrow in foreign currency. Somewhat paradoxically, an increase in the devaluation risk may lead domestic borrowers to take less insurance against this risk. (pages 190 - 217)
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Why Do Countries Borrow the Way They Borrow? - Marcos Chamon, Ricardo Hausmann
DOI: 10.7208/chicago/9780226194578.003.0009
[liability denomination, optimal monetary response, domestic interest rate, long-term market, original sin, domestic markets, exchange rate, monetary policy, interest rate]
This chapter explores the interplay between an individual borrower's choices for liability denomination through their effect on the optimal monetary response of the central bank, given those choices. It starts from the assumption that the debt in domestic currency cannot be contracted at long maturities and at fixed rates. As a result, the terms in which it is rolled over or repriced will depend on changes in the domestic interest rate. The chapter explains why the absence of a domestic long-term market may preclude the ability to borrow in local currency, but not why big problems persist even in the presence of long-term domestic markets. In the chapter, there is a shock to the expected future exchange rate. Since agents are forward looking, that shock affects the present interest and exchange rates. The central bank uses monetary policy to determine how the absorption of that shock is divided between changes in the interest rate and in the exchange rate. (pages 218 - 232)
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The Mystery of Original Sin - Barry Eichengreen, Ricardo Hausmann, Ugo Panizza
DOI: 10.7208/chicago/9780226194578.003.0010
[original sin, standard policy, institutional variables, emerging markets, international financial system]
This chapter analyzes the mystery of original sin using several indicators. It presents evidence of the explanatory power of a series of alternative explanations. The surprising finding is that the conventional hypotheses have remarkably little explanatory power for the phenomenon at hand. In other words, the standard policy and institutional variables shed remarkably little light on why so many emerging markets find it so difficult to borrow abroad in their own currencies, and they offer little in the way of an explanation for why a small number of emerging markets have been able to escape this plight. These results prompted the author to explore the possibility that the problem of original sin has at least as much to do with the structure and operation of the international financial system as with the weakness of policies and institutions. (pages 233 - 265)
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Original Sin - Barry Eichengreen, Ricardo Hausmann
DOI: 10.7208/chicago/9780226194578.003.0011
[synthetic unit, emerging-market economies, international financial institutions, liquid market, claims, World Bank, insurance markets, terms-of-trade risk, financial markets]
This chapter proposes the creation of a synthetic unit of account in which claims on a diversified group of emerging-market economies can be denominated, together with steps by the international financial institutions to develop a liquid market in claims denominated in this unit. As this new unit conquers space in the global portfolio, it will become possible for emerging-market borrowers to issue claims denominated in the underlying currencies and to place them on international markets. The result will be a more efficient international diversification of risks and a reduction in financial fragility. The World Bank has attempted to promote the development of insurance markets for terms-of-trade risk. The chapter's proposal is one more attempt, in this spirit, to help to complete incomplete financial markets. (pages 266 - 288)
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List of Contributors
Index
