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An Interest Rate Defence of a Fixed Exchange Rate?

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Author Info
Flood, Robert P
Jeanne, Olivier

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Abstract

Defending a government's exchange-rate commitment with active interest rate policy is not an option in the Krugman-Flood-Garber (KFG) model of speculative attacks. In that model, the interest rate is the passive reflection of currency-depreciation expectations. In this paper we show how to adapt the KFG model to allow for an interest rate defence. It is shown that increasing domestic-currency interest rate makes domestic assets more attractive according to an asset substitution effect, but weakens the domestic currency by increasing the government's fiscal liabilities. As a result raising the interest rate hastens the speculative attack when speculation is motivated by underlying fiscal fragility.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2507.

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Date of creation: Jul 2000
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Handle: RePEc:cpr:ceprdp:2507

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Related research
Keywords: Fiscal Policy; Fixed Exchange Rate Regime; Speculative Attack;

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Find related papers by JEL classification:
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Flood, Robert P & Garber, Peter M, 1984. "Gold Monetization and Gold Discipline," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 90-107, February. [Downloadable!] (restricted)
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  2. Cuthbertson, Keith & Galindo, Luis, 1999. "The Demand for Money in Mexico," Manchester School, University of Manchester, vol. 67(2), pages 154-66, March. [Downloadable!] (restricted)
  3. Kraay, Aart, 2003. "Do high interest rates defend currencies during speculative attacks?," Journal of International Economics, Elsevier, vol. 59(2), pages 297-321, March. [Downloadable!] (restricted)
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  4. Baig, Taimur & Goldfajn, Ilan, 2002. "Monetary Policy in the Aftermath of Currency Crises: The Case of Asia," Review of International Economics, Blackwell Publishing, vol. 10(1), pages 92-112, February. [Downloadable!] (restricted)
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  5. Andrew Berg, 1999. "The Asia Crisis - Causes, Policy Responses and Outcomes," IMF Working Papers 99/138, International Monetary Fund.
  6. Atish R. Ghosh & A. Javier Hamann & Timothy D. Lane & Steven Phillips & Marianne Schulze-Gattas & T. M. Tsikata, 1999. "IMF-Supported Programs in Indonesia, Korea and Thailand," IMF Occasional Papers 178, International Monetary Fund. [Downloadable!]
  7. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Amartya Lahiri & Carlos A. Vegh, 2000. "Delaying the Inevitable: Optimal Interest Rate Policy and BOP Crises," NBER Working Papers 7734, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Buiter, Willem H., 1987. "Borrowing to defend the exchange rate and the timing and magnitude of speculative attacks," Journal of International Economics, Elsevier, vol. 23(3-4), pages 221-239, November. [Downloadable!] (restricted)
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  10. Burnside, C. & Eichenbaum, M. & Rebelo, S., 1998. "Prospective Deficits and the Asian Currency Crisis," RCER Working Papers 458, University of Rochester - Center for Economic Research (RCER).
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  11. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August. [Downloadable!] (restricted)
  12. Flood, Robert & Marion, Nancy, 1999. "Perspectives on the Recent Currency Crisis Literature," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 1-26, January. [Downloadable!] (restricted)
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  13. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March. [Downloadable!] (restricted)
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  14. Olivier Jeanne & Andrew K. Rose, 1999. "Noise Trading and Exchange Rate Regimes," NBER Working Papers 7104, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Betty Daniel, 2000. "A Fiscal Theory of Currency Crises," Econometric Society World Congress 2000 Contributed Papers 0535, Econometric Society. [Downloadable!]
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  16. Bensaid, Bernard & Jeanne, Olivier, 1997. "The instability of fixed exchange rate systems when raising the nominal interest rate is costly," European Economic Review, Elsevier, vol. 41(8), pages 1461-1478, August. [Downloadable!] (restricted)
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