Abstract
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.
Highlights
Many countries at the centre of the Asian financial crisis adopted a high interest rate policy in an attempt to defend their currencies
We have reexamined the effects on Asian exchange rates of higher interest rates during the Asian financial crisis
In contrast to most previous studies, we find that higher interest rates provided support for many Asian exchange rates during the crisis
Summary
Many countries at the centre of the Asian financial crisis adopted a high interest rate policy in an attempt to defend their currencies. They believe that when balance of payment crises occur simultaneously with financial crises, as is the case of the Asian financial crisis, a tightening of monetary policy may be counter productive This is because, they argue, sharply higher interest rates will adversely affect economic activity and financial market confidence. Hsiao’s approach allows the presence of zero and nonzero patterned coefficients in a VAR system, the model specification is determined by applying an order selection algorithm to each single equation separately, rather than to the system as a whole. As demonstrated by Penm and Terrell [15], the so-determined specification can lead to misleading conclusions on the presence of Granger causality in the system To overcome this shortfall, Penm and Terrell [15] provide a robust algorithm to select the optimal VAR specification with zero and nonzero patterned coefficients (if the underlying system has such a structure).
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