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Do high interest rates defend currencies during speculative attacks New evidence

  • Goderis, Benedikt
  • Ioannidou, Vasso P.

The appropriate stance of monetary policy during speculative attacks has been the source of much controversy. According to the `traditional view`, a tighter monetary policy is necessary to discourage the outflow of capital, and thus prevent the exchange rate from depreciating. The `revisionist view` argues that when speculative attacks are accompanied by substantial balance-sheet problems in the private sector, a tightening of monetary policy may actually increase the probability of devaluation. In this paper we construct a dataset that includes data on corporate short-term debt and country-specific indicators of monetary policy for countries with fixed exchange-rate regimes that faced severe speculation against their currency during the period 1986-2002. The results show that for levels of short-term debt that are not too high, an increase in interest rates decreases the probability of a currency crisis - supportive of the traditional view. This effect decreases, and eventually changes sign for higher levels of debt - supportive of the revisionist view.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 74 (2008)
Issue (Month): 1 (January)
Pages: 158-169

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Handle: RePEc:eee:inecon:v:74:y:2008:i:1:p:158-169
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