Arbeitspapier

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

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.

Language
Englisch

Bibliographic citation
Series: Economics Discussion Papers ; No. 2016-3

Classification
Wirtschaft
Financial Crises
Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems
Monetary Policy
Central Banks and Their Policies
Subject
financial crises
capital controls
policy rates
exchange rates

Event
Geistige Schöpfung
(who)
Gudmundsson, Gudmundur S.
Zoega, Gylfi
Event
Veröffentlichung
(who)
Kiel Institute for the World Economy (IfW)
(where)
Kiel
(when)
2016

Handle
Last update
10.03.2025, 11:43 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Gudmundsson, Gudmundur S.
  • Zoega, Gylfi
  • Kiel Institute for the World Economy (IfW)

Time of origin

  • 2016

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