Monetary Policy, Default Risk and the Exchange Rate
AbstractIn a country with high probability of default, higher interest rates may render the currency less attractive if sovereign default is costly. This paper develops that intuition in a simple model and estimates the effect of changes in interest rates on the exchange rate in Brazil using data from the dates surrounding the monetary policy committee meetings and the methodology of identification through heteroskedasticity. Indeed, we find that unexpected increases in interest rates tend to lead the Brazilian currency to depreciate. It follows that granting more independence to a central bank that focus solely on inflation is not always a free-lunch.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6501.
Date of creation: Sep 2007
Date of revision:
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Find related papers by JEL classification:
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- F3 - International Economics - - International Finance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-06 (All new papers)
- NEP-CBA-2007-10-06 (Central Banking)
- NEP-IFN-2007-10-06 (International Finance)
- NEP-MAC-2007-10-06 (Macroeconomics)
- NEP-MON-2007-10-06 (Monetary Economics)
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