Currency Crises and Contingent Liabilities

Abstract

A contingent liability is a future spending commitment that is realized with some probability. International organizations emphasize the dangers of contingent liabilities when providing advice. Why? One answer is obvious-if significant contingent liabilities are realized they commit governments to substantial fiscal costs. There is a further reason: by taking on a contingent liability the government can increase the probability of the underlying shock taking place. This paper describes how the issuance of government guarantees and the methods by which they are financed affect the probability of crises taking place. It also discusses the determinants of post-crisis inflation and depreciation.