Do High Interest Rates Defend Currencies During Speculative Attacks?

Do High Interest Rates Defend Currencies During Speculative Attacks?

by Tyler Cowen on January 29, 2014 at 12:01 am in Current AffairsEconomics | Permalink

That is the question posed by a paper (pdf) by Aart Kraay of the World Bank, written in 2001 and focusing mainly on fixed exchange rate scenarios.  It seems the high rates do not protect currency values, here is the abstract:

Do high interest rates defend currencies during speculative attacks? Or do they have the perverse effect of increasing the probability of a devaluation of the currency under attack? Drawing on evidence from a large sample of speculative attacks in developed and developing economies, this paper argues that the answer to both questions is ”no”. In particular, this paper documents a striking lack of any systematic association whatsoever between interest rates and the outcome of speculative attacks. The lack of clear empirical evidence on the effects of high interest rates during speculative attacks mirrors the theoretical ambiguities on this issue.

This study (jstor) from the JPE, by Lahiri and Vegh, shows mixed results and also explains why the higher interest rates may be counterproductive.  They increase public debt service and may predict higher future inflation, thereby worsening some of the constraints and possibly hastening a further speculative attack.

Here is an Allan Drazen survey on raising interest rates to defend a currency (pdf), much of which focuses on the signaling effect.  He argues the non-signaling effects are generally weak and when it comes to the signaling effects it can cut either way.  Needing a large rate hike to defend a currency is in some ways a negative signal as well.  The empirics are discussed starting on p.51 and one result seems to be short-term benefits and medium-term deterioration, following a big interest rate hike to protect a currency.  Again, you will note this estimation is drawn from a lot of fixed rate countries and it may apply to floating rate scenarios only with qualifications.

You will find other relevant readings here.

The big news, of course, is that the Turkish central bank yesterday announced a 425bp rate hike, to stem a currency crisis.  There is FT Alphaville on the move here, more readings here.  The markets seem to like this move, at least at first, but based on what we know from the literature, we should not be too quick to think this will succeed.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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