Debauchery and Original Sin: The Currency Composition of Sovereign Debt

Abstract We present a model that accounts for the “mystery of original sin” and surge in local-currency borrowing by emerging economies recent decade. quantitatively investigate currency composition sovereign debt presence two types limited enforcement frictions arising from government's monetary policy: strategic debasement default on debt. Local-currency obligations act as better consumption hedge against income shocks than foreign-currency because their real value can be affected policy. However, this provides government with more temptation to deviate disciplined policy, thus restricting local foreign currency. Our predicts country less credible policy borrows mainly substitute credibility. An important extension demonstrates an expectational Phillips curve, improves ability policymakers commit.