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The Effect of Monetary Policy on Exchange Rates during Currency Crises: the Role of Debt, Institutions, and Financial Openness *
Author(s) -
Eijffinger Sylvester C. W.,
Goderis Benedikt
Publication year - 2008
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/j.1467-9396.2008.00745.x
Subject(s) - economics , monetary economics , openness to experience , debt , credibility , currency , monetary policy , capital account , exchange rate , external debt , international economics , macroeconomics , psychology , social psychology , political science , law
This paper empirically examines the effect of monetary policy on exchange rates during currency crises. We find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short‐term debt; (ii) is more credible and therefore more effective in countries with high‐quality institutions; (iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature.