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Causal relation between interest and exchange rates in the Asian currency crisis

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  • Choi, In
  • Park, Daekeun
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Abstract

This paper studies the causal relationship between interest rates and exchange rates in Indonesia, Korea, Malaysia and Thailand during the period bordering the 1997 Asian currency crisis to investigate the appropriateness of tight monetary policy in stabilizing exchange rates. We employ VAR models consisting of spot rates, forward rates and interest rate differentials to study the causal relations. In particular, we test for long-run causality as well as short-run causality by taking into account non-stationarity of the involved variables and the cointegrating relations among them. The test results show that except for some subsamples for Malaysia there is no evidence that interest rate differentials caused spot exchange rates at all horizons. Considering the ineffectiveness of high interest rates in stabilizing exchange rates and the high economic cost associated with keeping high interest rates for an extended time period, one may rightfully question the appropriateness of tight monetary policy during the Asian currency crisis.

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Bibliographic Info

Article provided by Elsevier in its journal Japan and the World Economy.

Volume (Year): 20 (2008)
Issue (Month): 3 (August)
Pages: 435-452

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Handle: RePEc:eee:japwor:v:20:y:2008:i:3:p:435-452

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Web page: http://www.elsevier.com/locate/inca/505557

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  1. Choi, In, 1994. "Durbin-Hausman tests for cointegration," Journal of Economic Dynamics and Control, Elsevier, vol. 18(2), pages 467-480, March.
  2. Saikkonen, Pentti, 1991. "Asymptotically Efficient Estimation of Cointegration Regressions," Econometric Theory, Cambridge University Press, vol. 7(01), pages 1-21, March.
  3. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  4. Peter C.B. Phillips & Sam Ouliaris, 1987. "Asymptotic Properties of Residual Based Tests for Cointegration," Cowles Foundation Discussion Papers 847R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1988.
  5. Dekle, Robert & Hsiao, Cheng & Wang, Siyan, 2002. "High Interest Rates and Exchange Rate Stabilization in Korea, Malaysia, and Thailand: An Empirical Investigation of the Traditional and Revisionist Views," Review of International Economics, Wiley Blackwell, vol. 10(1), pages 64-78, February.
  6. Toda, Hiro Y & Phillips, Peter C B, 1993. "Vector Autoregressions and Causality," Econometrica, Econometric Society, vol. 61(6), pages 1367-93, November.
  7. Baig, Taimur & Goldfajn, Ilan, 2002. "Monetary Policy in the Aftermath of Currency Crises: The Case of Asia," Review of International Economics, Wiley Blackwell, vol. 10(1), pages 92-112, February.
  8. Jason Furman & Joseph E. Stiglitz, 1998. "Economic Crises: Evidence and Insights from East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 1-136.
  9. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
  10. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "What Caused the Asian Currency and Financial Crisis?," Temi di discussione (Economic working papers) 343, Bank of Italy, Economic Research and International Relations Area.
  11. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  12. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  13. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  14. Byeongseon, Seo, 1998. "Statistical inference on cointegration rank in error correction models with stationary covariates," Journal of Econometrics, Elsevier, vol. 85(2), pages 339-385, August.
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