An Interest Rate Defense of a Fixed Exchange Rate?

Topics:
Commercial Banking
Tags:
Finance,
Financial Planning,
Financial Services,
Interest Rate
Source:
International Monetary Fund

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Overview: This white paper deals with a model, in which the interest rate is the passive reflection of currency-depreciation expectations. This paper shows how to adapt the KFG model to allow for an interest rate defense. It is shown that increasing 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.

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Format: PDF | Size: 138KB | Date: Apr 2000 | Pages: 21

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