2018 (15), №3

Fiscal Pоliсy under the Threat оf a Twin Crisis



For citation: 

Сhеlеkhоvskiy, A. N. & Khabibullin, R. A. (2018). Fiscal Pоliсy under the Threat оf a Twin Crisis. Zhurnal Economicheskoj Teorii [Russian Journal of Economic Theory], 15(3), 429-441


When the central bank denies to maintain the fixed exchange rate, it creates a threat of default as the government external debt increases. In this case, fiscal authorities make a strategic decision whether to default and finance public purchases only through tax revenues and seigniorage or to pay government debt. The authors of this article created a model in order to explain the government’s choice. The model shows how fiscal authorities compare social welfare in these two strategies. The main difference of this model from the models described in the scientific papers is that the authors included the option of the desirable seigniorage choice. Seigniorage gives government additional inducements to default as in case of default benevolent government can use seigniorage to finance most of government expenses and increase the utility of households. The analysis of the model has shown that at a certain level of debt and certain factor productivity, a benevolent government can default if central bank denies to maintain the fixed exchange rate, even when foreign investors trust the government. The authors state that the incentives to default are higher in countries where the factor productivity is low and the initial debt is high. The results are shown on the examples of currency crises in Mexico 1994-1995, Argentina 2001-2002 and Turkey 2000-2001. A meaningful constraint of the model presented by the authors is the modeling of the foreign investors’ behavior who consider the default impossible. Introducing endogenous expectations of government bonds holders into the model can help to explain a twin crisis as a selffulfilling prophecy and explain factors that influence a government choice between default and payment of the government debt in case of devaluation.

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Chelekhovskiy Aleksandr NikolaevichDepartment of Theoretical Economics, Faculty of Economic Sciences, National Research University Higher School of Economics (Moscow, Russian Federation, e-mail: ashеlekhоvskiy@hse.ru).

Khabibullin Ramis Arslanovich Bank of Russia; Research and Educational Laboratory for Macroeconomic Analysis, National Research University Higher School of Economics (Moscow, RF, е-mail: rkhabibullin@ hse.ru).