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Do Interest Rates Affect the Exchange Rate under Capital Controls? An event study of Iceland’s experience with capital controls

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  • Ágúst Arnórsson
  • Gylfi Zoega

Abstract

We find that both actual changes and unexpected changes in interest rates affect the average exchange rate in Iceland when the year 2009 is included in the sample that ends in August of this year but not when it is excluded. This early period was characterized by lax capital controls until the autumn of 2009. It follows that, given the moderate changes of interest rates observed in the data, using interest rates to stabilise the exchange rate may work when the capital controls are not effectively enforced but is not as useful when they are enforced. However, it should be noted that large changes in interest rates may have an effect on exchange rates when capital controls are enforced, although such changes never occurred during our sample period.

Suggested Citation

  • Ágúst Arnórsson & Gylfi Zoega, 2015. "Do Interest Rates Affect the Exchange Rate under Capital Controls? An event study of Iceland’s experience with capital controls," Economics wp70, Department of Economics, Central bank of Iceland.
  • Handle: RePEc:ice:wpaper:wp70
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    References listed on IDEAS

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    5. Caporale, Guglielmo Maria & Cipollini, Andrea & Demetriades, Panicos O., 2005. "Monetary policy and the exchange rate during the Asian crisis: identification through heteroscedasticity," Journal of International Money and Finance, Elsevier, vol. 24(1), pages 39-53, February.
    6. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, vol. 99(396), pages 376-391, June.
    7. Calvo, Guillermo A. & Izquierdo, Alejandro & Loo-Kung, Rudy, 2006. "Relative price volatility under Sudden Stops: The relevance of balance sheet effects," Journal of International Economics, Elsevier, vol. 69(1), pages 231-254, June.
    8. Christopher W. Crowe & Jonathan David Ostry & Jun I Kim & Marcos d Chamon & Atish R. Ghosh, 2009. "Coping with the Crisis; Policy Options for Emerging Market Countries," IMF Staff Position Notes 2009/08, International Monetary Fund.
    9. Akira Ariyoshi & Andrei A Kirilenko & Inci Ötker & Bernard J Laurens & Jorge I Canales Kriljenko & Karl F Habermeier, 2000. "Capital Controls; Country Experiences with Their Use and Liberalization," IMF Occasional Papers 190, International Monetary Fund.
    10. Miguel Lacerda & Johannes W. Fedderke & Linda M. Haines, 2010. "Testing For Purchasing Power Parity And Uncovered Interest Parity In The Presence Of Monetary And Exchange Rate Regime Shifts," South African Journal of Economics, Economic Society of South Africa, vol. 78(4), pages 363-382, December.
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