Ricardo Hausmann - Original Sin

Original Sin

The expression original sin was first used in international finance in a 1999 article by Barry Eichengreen and Ricardo Hausmann. The authors define original sin as a situation in which the residents (or government) of a country are unable to borrow in their own domestic currency. In other words, a poor country is forced to borrow funds denominated in foreign exchange (e.g. the U.S. dollar, the euro, or the yen). Based on their measure of original sin the authors show that original sin was present in most of the developing economies and independent from histories of high inflation and currency depreciation. This is seen as problematic because if the borrowing country's domestic currency depreciates, the loan will become more difficult to pay back, since their currency is now worth less relative to the loan.

Later research has mainly focused on the international component of original sin: the inability of most countries to borrow abroad in their own currency. Barry Eichengreen, Ricardo Hausmann and Ugo Panizza show that almost all of the countries (except US, Euro area, Japan, UK, and Switzerland) suffered from (international) original sin over time. The authors argued that this international component of original sin has serious consequences. It makes debt riskier, increases volatility, and affects a country's ability to conduct an independent monetary policy. This is because original sin is likely to cause a currency mismatch in the national balance sheet of a country: the currencies of its assets and those of its liabilities do not correspond. Thus, large swings in the real exchange rate will have an effect on aggregate wealth and it will be more difficult for the country to service its debt. In other words, original sin tends to make the fiscal balance dependent on the real exchange rate and the short term real interest rate.

Criticism on the concept of original sin has been twofold. On the one hand, Morris Goldstein and Philip Turner claim that original sin is not a sufficient condition for a currency mismatch, and thus cannot account for the large output losses due to the currency mismatches during financial crises . On the other hand, Carmen Reinhart, Kenneth Rogoff and Miguel Savastano claim that the main problem of emerging market economies is to learn how to borrow less rather than learn how to borrow more in their domestic currency. They assumed that the problems of emerging markets were not due to original sin, but to so-called debt intolerance: the inability of to manage levels of external debt that, under the same circumstances, would be manageable for developed countries. Eichengreen, Hausmann and Panizza respond to both criticisms in a paper elaborating the difference between currency mismatches, debt intolerance and original sin.