A fiscal perspective on currency crises and the 'original sin' ∗

Maturity and currency denomination of public debt are crucial determinants of macroeconomic dynamics in an open economy. The focus of this paper is on dynamics in reaction to a shock that increases the real value of debt relative to government’s primary surpluses. In response to such a shock, the rate of price level inflation and exchange rate devaluation depend on denomination of debt, whereas their timing – on nominal debt’s maturity. The adjustment to a fiscal imbalance can take the form of a real appreciation and a current account deficit if the exchange rate parity is kept temporarily fixed, followed by a real depreciation and a current account surplus coincident with devaluation. Our analysis suggests a broader view of: (1) fiscal consequences of inflation and devaluation, (2) macroeconomic effects of fiscal shocks, and (3) interations between fiscal and monetary policy, relative to standards in the open-economy literature.