Deciding To Peg The Exchange Rate In Developing Countries: The Role Of Private-Sector Debt

The authors argue that a higher share of the private sector in a country's external debt raises the incentive to stabilize the exchange rate. They present a simple model in which exchange rate volatility does not affect agents' welfare if all the debt is incurred by the government. Once they introduce private banks who borrow in foreign currency and lend to domestic firms, the monetary authority has an incentive to dampen the distributional consequences of exchange rate fluctuations.