A double-edged sword: High interest rates in capital control regimes

Gudmundur S. Gudmundsson and Gylfi Zoega

No 2016-3, Economics Discussion Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: This paper describes the relationship between central bank interest rates and exchange rates under a capital control regime. Higher interest rates may strengthen the currency by inducing 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 may also increase the flow of interest income to foreigners through the current account, making 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 it highlights the importance of effective enforcement 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)
Date: 2016
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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http://www.economics-ejournal.org/economics/discussionpapers/2016-3
https://www.econstor.eu/bitstream/10419/126143/1/846392259.pdf (application/pdf)

Related works:
Working Paper: A Double-edged Sword: High Interest Rates in Capital-control Regimes (2010)
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:zbw:ifwedp:20163

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