Falcetti, Elisabetta
(2004)
Sources of financial fragility: The role of debt management.
PhD thesis, London School of Economics and Political Science.
Abstract
The main aim of this thesis is to investigate from both a theoretical and empirical point of view how debt management may affect the choice of the monetary and exchange rate regimes and ultimately influence the stability of financial systems. The thesis is organised as follows. In Chapter 1, we develop a simple theoretical model to analyse how the choice of the maturity and denomination of public debt instruments affects the choice of the optimal monetary target. We then compare debt management to alternative institutional mechanism designs and find that delegation of monetary policy to an independent central banker is a better solution to inflationary temptations than the issuance of foreign or indexed debt. Chapter 2 extends the analysis and shows that foreign currency debt may reduce the probability of a collapse of a fixed exchange rate regime. However, conditional on a currency crisis, countries with larger shares of foreign currency debt tend to experience sharper devaluations. Econometric results referring to the countries adhering to the Exchange Rate Mechanism of the European Monetary System from 1979 to 1995 confirm these theoretical findings. In the second part of the thesis we look at the sources of financial vulnerability in a sample of emerging and developing countries from 1970 to 1997. In Chapter 3, we test the role of debt and exchange rate fragility in determining episodes of banking crises, while Chapter 4 extends the analysis of the causal link between currency and banking crises to episodes of twin crises. The results indicate that along with the increasing liberalisation and globalisation of the financial markets, banking and currency crises have become closely intertwined and driven by common fundamentals. Finally, Chapter 5 contains a description of the econometric specifications and simulation-based estimation techniques adopted in the second part of the thesis.
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