Debt and Currency Crises—Complements or Substitutes?*

Abstract

AbstractDebt and currency crises are closely interlinked through the government's intertemporal budget constraint. The default tax and the inflation/devaluation tax can be considered as alternative means of financing. Our empirical analysis finds that high‐debt countries choose default rather than inflation/devaluation for financing, while a high money stock reduces the probability of debt crises. Further, we find strong evidence that debt and currency crises share common fundamental causes. Finally, there is a Granger causality running from debt crises to currency crises, but only weakly in the other direction.