The Pain of Original Sin

Abstract

Abstract This chapter shows that the composition of external debt—and specifically the extent to which that debt is denominated in foreign currency—is a key determinant of the stability of output, the volatility of capital flows, the management of exchange rates, and the level of country credit ratings. It presents empirical analysis demonstrating that this “original sin” problem has statistically significant and economically important implications, even after controlling for other conventional determinants of macroeconomic outcomes. The chapter shows that the macroeconomic policies on which growth and cyclical stability depend, according to conventional wisdom, are themselves importantly shaped by the denomination of countries' external debts. Establishing the importance of original sin for the macroeconomic outcomes of interest requires a precise measure of the phenomenon.

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