Comments on Chapter 5 – The economics of Cacania, 1867–1914. Austro-Hungarian monetary lessons for Euroland
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Yet the description of a growing share of foreign debt as an optimal commitment mechanism to improve public finances management can not be generalised to all situations. Foreign debt certainly induces governments to emphasise exchange rate stability, but governments can use fixed exchange rates to reduce artificially the interest rate and the risk premium in order to be able to prolong unsustainable financial policies, concealed by market discipline rhetoric. The usual outcome of such a policy is an overvalued real exchange rate followed by a sudden and violent devaluation. The real weight of foreign debt is magnified by the collapse of the currency, worsening further internal and external finances. Market discipline is a double edged sword; it can be tampered with for a time and then deliver a fatal blow to those who tried to manipulate it.