A Double-edged Sword: High Interest Rates in Capital-control Regimes

Gylfi Zoega

DEGIT Conference Papers from DEGIT, Dynamics, Economic Growth, and International Trade

Abstract: This paper derives the relationship between central bank interest rates and exchange rates under a capital control regime. Higher interest rate may strengthen the currency by reducing consumption and imports and by inducing foreign owners of local currency assets not to sell local currency off shore. There is also an effect that goes in the opposite direction: Higher interest rates increase the flow of interest income to foreigners through the current account which makes the exchange rate fall. The historical financial crisis now under way in Iceland provides excellent testing grounds for the analysis. Overall, the experience does not suggest that cutting interest rates moderately from a very high level is likely to make a currency depreciate in a capital control regime but highlights the importance of effective enforcing of the controls.

Keywords: Financial crises; capital controls; policy rates; exchange rates (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 G01 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2010-09
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Related works:
Journal Article: A double-edged sword: High interest rates in capital control regimes (2016)
Working Paper: A double-edged sword: High interest rates in capital control regimes (2016)
Working Paper: A double-edged sword. High interest rates in capital-control regimes (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:deg:conpap:c015_048

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