TY  - JOUR
AU  - Drazen,Allan
AU  - Hubrich,Stefan
TI  - A Simple Test of the Effect of Interest Rate Defense
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12616
PY  - 2006
Y2  - October 2006
UR  - http://www.nber.org/papers/w12616
L1  - http://www.nber.org/papers/w12616.pdf
N1  - Author contact info:
Allan Drazen
Department of Economics
University of Maryland
College Park, MD 20742
Tel: 301/405-3477
Fax: 301/405-7835
E-Mail: drazen@econ.umd.edu

Stefan Hubrich
T. Rowe Price Associates, Inc.
100 East Pratt St.
Baltimore, MD 21202
E-Mail: stefan_hubrich@troweprice.com
AB  - High interest rates to defend the exchange rate signal that a government is committed to fixed exchange rates, but may also signal weak fundamentals.  We test the effectiveness of the interest rate defense by disaggregating into the effects on future interest rates differentials, expectations of future exchange rates, and risk premia.  While much previous empirical work has been inconclusive due to offsetting effects, tests that "disaggregate" the effects provide significant information.  Raising overnight interest rates strengthens the exchange rate over the short-term, but also leads to an expected depreciation at a horizon of a year and longer and an increase in the risk premium, consistent with the argument that it also signals weak fundamentals.
ER  -