DP2918 On the Fiscal Implications of Twin Crises

Author(s): Craig Burnside, Martin Eichenbaum, Sérgio Rebelo
Publication Date: August 2001
Keyword(s): bailouts, banking crisis, currency crisis, fiscal reform, seignorage, speculative attacks
JEL(s): F31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2918

This Paper explores the implications of different strategies for financing the fiscal costs of twin crises in inflation and depreciation rates. We use a first-generation type model of speculative attacks which has four key features: (i) the crisis is triggered by prospective deficits: (ii) there exists outstanding non-indexed government debt issued prior to the crises; (iii) a portion of the governments liabilities are not indexed to inflation; and (iv) there are nontradable goods and costs of distributing tradable goods, so that purchasing power parity does not hold. We show that the model can account for the high rates of devaluation and moderate rates of inflation often observed in the wake of currency crises. We use our model and the data to interpret the recent currency crises in Mexico and Korea. Our analysis suggests that the Mexican government is likely to pay for the bulk of the fiscal costs of its crisis through seignorage revenues. In contrast, the Korean government is likely to rely more on a combination of implicit and explicit fiscal reforms.