The Interest Rate-Exchange Rate Nexus in Currency Crises (original) (raw)

Effectiveness of high interest rate policy on exchange rates: A reexamination of the Asian financial crisis

Journal of Applied Mathematics and Decision Sciences, 2006

One of the most controversial issues in the aftermath of the Asian financial crisis has been the appropriate response of monetary policy to a sharp decline in the value of some currencies. In this paper, we empirically examine the effects on Asian exchange rates of sharply higher interest rates during the Asian financial crisis. Taking account of the currency contagion effect, our results indicate that sharply higher interest rates helped to support the exchange rates of South Korea, the Philippines, and Thailand. For Malaysia, no significant causal relation is found from the rate of interest to exchange rates, as the authorities in Malaysia did not actively adopt a high interest rate policy to defend the currency.

Economic activity, foreign exchange rate, and the interest rate during the Asian crisis

Journal of Policy Modeling, 2006

In a simple linear rational expectations model in which monetary authorities act to stabilize the exchange rate and also to mitigate adverse effects on real activity, a rise in interest rate is followed by exchange rate depreciation. In daily data across VAR and VECM models a rise in interest rate is associated with significant exchange rate depreciation for Thailand, the Philippines, and Korea. Depreciation and increases in the interest rate raise business failures that intensify crisis. Crisis management of the exchange rate must consider damaging effect of restrictive policy on financially constrained banking sector and non-financial firms.

Traditional view or revisionist view? The effects of monetary policy on exchange rates in Asia

Applied Financial Economics, 2010

This paper investigates the channels through which the short-term interest rate is used as an instrument to stabilize the exchange rates in Asia during the financial crisis in the 1990s. A time-varying-parameter model with GARCH disturbances is employed to estimate the dynamic effect of the interest rate on the exchange rate. We distinguish the direct effect from the indirect effect. The direct effect exists so that a contractionary monetary policy can have an appreciation impact (the traditional view). The indirect effect refers to the higher default risk induced by a monetary policy tightening, which on the contrary generates a depreciation pressure (the revisionist view). Using weekly data from Indonesia, South Korea, and Thailand from 1997:7 to 1998:12, we find that there is no significant evidence in favor of the traditional view. The revisionist view is clearly in effect in Thailand at the very beginning of the crisis.

The Empirical Relationship Between Exchange Rates and Interest Rates in Post-Crisis Asia

2004

In post-crisis Asia, all crisis-hit countries (except Malaysia) announced a shift from exchange rate based monetary policy framework to the explicit adoption of inflation targeting that uses interest rates as the key monetary policy operating instrument. In this study, we examine the empirical relationship between exchange rates and interest rates, and investigate how the dynamics between them have changed following the crisis. This is carried out by constructing a bivariate VAR-GARCH model for each of the four Asian crisis countries, namely Indonesia, Korea, Philippines and Thailand. The findings suggest these countries do not use interest rate policy more actively to stabilize exchange rates after the crisis, and provide evidence that their domestic currencies exhibit greater sensitivity to competitors’ exchange rates post-crisis. Further, the results indicate that increased exchange rate flexibility has not led to greater stability in interest rates in these economies.

The Effect of Foreign Debt on The Exchange Rate and Its Impact on Monetary Policy in Indonesia

Media Trend, 2019

The objectives of this study are to analyze the effect of foreign debt on the exchange rate that seen from the foreign debt and the exchange rate, and add the variable of inflationary monetary policy and the interest rate of BI Rate to test its impact on monetary policy in Indonesia. The approach in this study is quantitative approach. Data that used are Time Series data from Asian Development Bank and Indonesian World Bank in 1986-2013. Variables that used are exchange rate, foreign debt, inflation and the interest rate of BI Rate. Method that used in this study is Vector Auto Regression (VAR) analysis. The stages that used in this study testing are stationary test, optimal lag test, Granger causality test, impulse response test, and variance decomposite test in Eviews 6 program. The results of Granger causality test of all variables in this study are unlikely to have a relationship and there are only two variables that give an effect.Based on the results of Granger causality, it s...

Does greater exchange rate flexibility affect interest rates in post-crisis Asia?

Journal of Asian Economics, 2006

In post-crisis Asia, all crisis-hit countries (except Malaysia) announced a shift from an exchange rate based monetary policy framework to the adoption of inflation targeting which uses interest rates as the monetary policy operating instrument. In this study, we examine the empirical relationship between exchange rates and interest rates by applying a bivariate VAR-GARCH model to the Asian crisis countries, namely Indonesia, Korea, Philippines and Thailand. The findings suggest that, following the crisis, their currencies exhibit greater sensitivity to competitors' exchange rates, and that increased exchange rate flexibility stabilizes interest rates only in the short run.

Monetary Policy in the Aftermath of Currency Crises: The Case of Asia

Review of International Economics, 2002

The paper evaluates monetary policy and its relationship with the exchange rate in the five Asian crisis countries. The findings are compared with previous currency crises in recent history. It is found that there is no evidence of overly tight monetary policy in the Asian crisis countries in 1997 and early 1998. There is also no evidence that high interest rates led to weaker exchange rates. The usual tradeoff between inflation and output when raising interest rates suggested the need for a softer monetary policy in the crisis countries to combat recession. However, in some countries, corporate balance sheet considerations suggested the need to reverse overly depreciated currencies through firmer monetary policy.