Are hard pegs ever credible?

No says this paper from Kris James Mitchener and Marc D. Weidenmier. They point to evidence from Gold Standard days. 

Using a new database of weekly sovereign debt prices of paper currency and pound sterling (or gold) denominated debt, we identify the currency-risk component of sovereign yield spreads for nine of the largest emerging market borrowers for the period 1870-1913. Five years after a country joined the gold standard, paper currency bonds traded at significantly higher interest rates (more than 400 basis points on average) than a country’s foreign currency debt denominated in pound sterling. Investors also expected exchange rates to fall by roughly 20 percent even after emerging market borrowers had joined the gold standard. The presence of persistent positive currency risk premiums long after gold standard adoption suggests that hard pegs for emerging market borrowers may never be fully credible.

The authors say theirs is the first study to study the credibility of the hard peg via currency risk.

Given our interest in understanding the effects of exchange-rate regime choice on borrowing costs, the most direct way of testing the credibility of the gold standard is to examine the currency risk premium. Previous research on the gold standard has focused almost exclusively on country risk or political risk.

Our paper breaks new ground by examining thecurrency risk premium after gold standard adoption in order to assess the credibility of hard pegs for emerging market borrowers.

Nice paper bringing insights from economic history.

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