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Do high interest rates deter speculative attacks? - Evidence and some theory

  • Grier, Kevin
  • Lin, Shu

This paper presents the first empirical evidence on the efficacy of raising interest rates ex ante as a deterrent to speculative attacks. Using a dataset that covers 54 countries from March 1964 through December 2005, we find strong evidence that raising interest rates in advance has significantly different impacts in different country groups. It significantly reduces the probability of attacks in countries that have a de facto hard peg but increases it in de facto soft-pegging countries. This finding is robust to alternative measure of monetary policy and to different specifications and samples. We then present a simple two-stage signaling model to offer a theoretical explanation for our empirical findings.

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File URL: http://www.sciencedirect.com/science/article/B6V9S-4Y9CF3S-4/2/1d4a92f5572712797f321fb62184c035
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 29 (2010)
Issue (Month): 5 (September)
Pages: 938-950

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Handle: RePEc:eee:jimfin:v:29:y:2010:i:5:p:938-950
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Allan Drazen, 2003. "Interest Rate Defense against Speculative Attack as a Signal. A Primer," NBER Chapters, in: Managing Currency Crises in Emerging Markets, pages 37-60 National Bureau of Economic Research, Inc.
  2. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2006. "Signaling in a Global Game: Coordination and Policy Traps," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 452-484, June.
  3. Glick, Reuven & Guo, Xueyan & Hutchison, Michael M., 2004. "Currency Crises, Capital Account Liberalization, and Selection Bias," Santa Cruz Center for International Economics, Working Paper Series qt12t6x2ht, Center for International Economics, UC Santa Cruz.
  4. Amartya Lahiri & Carlos A. Vegh, 2003. "Delaying the Inevitable: Interest Rate Defense and Balance of Payments Crises," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 404-424, April.
  5. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February.
  6. Olivier Jeanne & Robert P. Flood, 2000. "An Interest Rate Defense of a Fixed Exchange Rate?," IMF Working Papers 00/159, International Monetary Fund.
  7. 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.
  8. Eduardo Levy-Yeyati & Federico Sturzenegger, 2003. "To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth," American Economic Review, American Economic Association, vol. 93(4), pages 1173-1193, September.
  9. Kraay, Aart, 2000. "Do high interest rates defend currencies during speculative attacks ?," Policy Research Working Paper Series 2267, The World Bank.
  10. Drazen, Allan, 2000. "Interest-rate and borrowing defense against speculative attack," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 303-348, December.
  11. King, Gary & Zeng, Langche, 2001. "Explaining Rare Events in International Relations," International Organization, Cambridge University Press, vol. 55(03), pages 693-715, June.
  12. David M. Gould & Steven B. Kamin, 2000. "The impact of monetary policy on exchange rates during financial crises," International Finance Discussion Papers 669, Board of Governors of the Federal Reserve System (U.S.).
  13. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  14. Bensaid, B.B. & Jeanne, O., 1995. "The Instability of Fixed Exchange Rate Systems when Raising the Nominal Interest Rate is Costly," Papers 9536, Tilburg - Center for Economic Research.
  15. Allan Drazen & Stefan Hubrich, 2006. "A Simple Test of the Effect of Interest Rate Defense," NBER Working Papers 12616, National Bureau of Economic Research, Inc.
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