The IMF's High Interest Rate Policy and Its Effects on the Stabilization of the Korean Won

Tae-Joon Kim and Jai-Won Ryou
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Tae-Joon Kim: Dongduk Women's University
Jai-Won Ryou: Konkuk University

East Asian Economic Review, 2000, vol. 4, issue 1, 137-168

Abstract: There has been a lively debate whether high interest rates were effective in stabilizing the exchange rate in the wake of the Asian currency crisis. Many economists insist that high interest rates not only failed to stabilize the Korean won, but also exacerbated the crisis itself. This paper tries to shed light on this problem by providing empirical evidence from the high interest rate period. (1997. 12. 3 ? 1998. 4. 8) If possible channels whereby interest rates may affect exchange rates are examined, the high interest rate policy scores well. It accommodated net capital inflow by satisfying the interest rate parity condition. Also it helped rebuild credibility of the policy stance. While the negative impact of high interest rates on the private sector cannot be denied, the role of credit crunch needs to be recognized together. Next, the dynamic interaction between interest rates and exchange rates is analyzed using a vector error correction model composed of interest rate differential, spot and forward exchange rates, and country risk premium. The estimation result shows that a 10% point rise in domestic interest rate appreciates the Korean won by 25%. In addition, the country risk premium considerably falls down. In sum, it may be concluded that the high interest rate policy was effective in achieving its goal of stabilizing exchange rates.

Keywords: IMF; High Interest Rate Policy; Exchange Rate; Korea Won (search for similar items in EconPapers)
JEL-codes: F32 G12 (search for similar items in EconPapers)
Date: 2000
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