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Monetary Policy and the Exchange Rate During the Asian Crisis Identification Through Heteroscedasticity

  • Guglielmo Maria Caporale
  • Andrea Cipollini
  • Panicos Demetriades


This paper examines whether a monetary policy tightening (i.e., an increase in the domestic interest rate) was successful in defending the exchange rate from speculative pressures during the Asian financial crisis. We estimate a bivariate VECM for four Asian countries, and improve upon existing studies in two important ways. First, by using a long data span we are able to compare the effects of an interest rate rise on the nominal exchange rate during tranquil and turbulent periods. Second, we take into account the endogeneity of interest rates and identify the system by exploiting the heteroscedasticity properties of the relevant time series, as suggested by Sentana and Fiorentini (2001). We find that while tight monetary policy helped to defend the exchange rate during tranquil periods, it had the opposite effect during the Asian crisis.

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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 00/11.

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Date of creation: Dec 2000
Date of revision: Feb 2002
Handle: RePEc:lec:leecon:00/11
Contact details of provider: Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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  5. Ilan Goldfajn & Poonam Gupta, 1999. "Does monetary policy stabilize the exchange rate following a currency crisis?," Textos para discussão 396, Department of Economics PUC-Rio (Brazil).
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  7. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  8. Evan Tanner, 1999. "Exchange Market Pressure and Monetary Policy: Asia and Latin America in the 1990s," IMF Working Papers 99/114, International Monetary Fund.
  9. Dekle, Robert & Hsiao, Cheng & Wang, Siyan, 2001. " Do High Interest Rates Appreciate Exchange Rates during Crisis? The Korean Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 63(3), pages 359-80, July.
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  17. 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.
  18. Fabio C. Bagliano & Carlo A. Favero, . "Information from financial markets and VAR measures of monetary policy," Working Papers 135, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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