Government guarantees and self-fulfilling speculative attacks

Burnside, C. , Eichenbaum, M. and Rebelo, S. (2004) Government guarantees and self-fulfilling speculative attacks. Journal of Economic Theory, 119(1), pp. 31-63. (doi: 10.1016/j.jet.2003.06.002)

Abstract

We develop a model in which government guarantees to banks’ foreign creditors are a root cause of self-fulfilling twin banking-currency crises. Absent guarantees, such crises are not possible. In the presence of guarantees banks borrow foreign currency, lend domestic currency and do not hedge the resulting exchange rate risk. With guarantees, banks will also renege on their foreign debts and declare bankruptcy when a devaluation occurs. We assume that the government is unable or unwilling to fully fund the resulting bailout via an explicit fiscal reform. These features of our model imply that government guarantees lead to self-fulfilling banking-currency crises.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Burnside, Professor Craig
• Authors: Burnside, C., Eichenbaum, M., and Rebelo, S.
• Subjects: H Social Sciences > HB Economic Theory
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: Journal of Economic Theory
• ISSN: 0022-0531
• Published Online: 14 November 2003