Monetary Policy, Default Risk and the Exchange Rate

Bernardo Guimaraes and ,
Authors registered in the RePEc Author Service: Carlos Eduardo Goncalves

No 6501, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In a country with high probability of default, higher interest rates may render the currency less attractive if sovereign default is costly. This paper develops that intuition in a simple model and estimates the effect of changes in interest rates on the exchange rate in Brazil using data from the dates surrounding the monetary policy committee meetings and the methodology of identification through heteroskedasticity. Indeed, we find that unexpected increases in interest rates tend to lead the Brazilian currency to depreciate. It follows that granting more independence to a central bank that focus solely on inflation is not always a free-lunch.

Keywords: Default; exchange rate; Identification through heteroskedasticity; Monetary policy (search for similar items in EconPapers)
JEL-codes: E5 F3 (search for similar items in EconPapers)
Date: 2007-09
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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