An Interest Rate Defense of a Fixed Exchange Rate?

October 1, 2000

Preview Citation

Format: Chicago

Olivier D Jeanne, and Robert P Flood. An Interest Rate Defense of a Fixed Exchange Rate?, (USA: International Monetary Fund, 2000) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Defending a government’s exchange-rate commitment with active interest rate policy is not an option in the Krugman-Flood-Garber (KFG) model of speculative attacks. In that model, the interest rate is the passive reflection of currency-depreciation expectations. In this paper we show how to adapt the KFG model to allow for an interest rate defense. It is shown that increasing the domestic-currency interest rate makes domestic assets more attractive according to an asset substitution effect, but weakens the domestic currency by increasing the government’s fiscal liabilities. As a result, raising the interest rate hastens the speculative attack when speculation is motivated by underlying fiscal fragility.

Subject: Conventional peg, Currencies, Demand for money, Exchange rates, Financial services, Foreign exchange, Interest rate parity, Money

Keywords: Collapse interest rate, Conventional peg, Currencies, Currency peg, Currency-peg collapse, Defense in the Krugman-Flood-Garber, Demand for money, East Asia, Exchange rates, Fiscal policy, Fixed exchange rate regime, Global, Ill-conceived interest rate strategy, Interest rate, Interest rate defense, Interest rate parity, Interest rate rise, Money supply, Nominal interest rate, Southeast Asia, Speculative attack, WP

Publication Details

Pages:

19
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2000/159
Stock No:

WPIEA1592000
ISBN:

9781451857665
ISSN:

1018-5941

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