A Simple Test of the Effect of Interest Rate Defense / Allan Drazen, Stefan Hubrich.

Format:

Book

Author/Creator:

Drazen, Allan.

Contributor:

National Bureau of Economic Research.

Hubrich, Stefan.

Series:

Working Paper Series (National Bureau of Economic Research) no. w12616.

NBER working paper series no. w12616

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2006.

Summary:

High interest rates to defend the exchange rate signal that a government is committed to fixed exchange rates, but may also signal weak fundamentals. We test the effectiveness of the interest rate defense by disaggregating into the effects on future interest rates differentials, expectations of future exchange rates, and risk premia. While much previous empirical work has been inconclusive due to offsetting effects, tests that "disaggregate" the effects provide significant information. Raising overnight interest rates strengthens the exchange rate over the short-term, but also leads to an expected depreciation at a horizon of a year and longer and an increase in the risk premium, consistent with the argument that it also signals weak fundamentals.

Notes:

Print version record

October 2006.