Abstract
Defending a government's exchange-rate commitment with active interest rate policy is not an option in first-generation models of speculative attacks. In those models, the interest rate is the passive reflection of currency-depreciation expectations. In this paper, we show how to adapt the first-generation framework to allow for an interest rate defense. It is shown that increasing domestic currency interest rate before the attack 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, an interest rate defense can be successful only conditional on sound fiscal policy.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.