EXCHANGE RATE STABILIZATION AND IMF HIGH INTEREST RATE POLICY: A CRITICAL RECONSIDERATION USING A DYNAMIC MODEL

Abstract

This paper examines whether the IMF high interest rate policy was suitable for crisis-ridden East Asian economies. Using an overshoot model similar to that of Dornbusch's (1976), it shows that this sort of policy might cause an unnecessary deflationary adjusting process and have no effect on containing the real depreciation of exchange rates in the long run. The study also demonstrates that Thai economic data coincides quite well with the model presented here. Finally, it points out that the high interest policy itself might provoke high risk-premium, the existence of which, in turn, justifies the policy. This means that the policy has a self-fulfilling property. In conclusion, a one-size-fits-all adaptation of high interest rate policy in a currency crisis is very dangerous in general, and was inappropriate for East Asia. The desirable policy would have been to let currencies depreciate and keep interest rates stable.