DP431 A Model of Currency Depreciation and the Debt-Inflation Spiral

Author(s): Maurice Obstfeld
Publication Date: July 1990
Keyword(s): Currency Depreciation, Dynamic Games, Markov-Perfect Equilibrium, Public Debt, Tax-Smoothing Models
JEL(s): 431
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=431

This paper shows how a government that cannot make credible policy commitments might manage its exchange rate and fiscal stance in a world of rational expectations. The dynamic-game model developed here potentially can generate diverse patterns of macroeconomic behaviour, patterns that differ as a result of assumed differences in government objectives. Under some types of government, the ongoing strategic interaction between the public and private sectors leads to a disinflationary outcome. Other governments may push the economy into a spiral of rising debt and inflation.