Do high interest rates defend fixed exchange rates during currency crises? A comprehensive empirical assessment

High interest rates are a potentially powerful tool for the defense of a fixed exchange rate regime facing speculative pressure. Their effectiveness at doing so, however, is put in question by both the stylized facts and the small empirical literature on monetary policy during currency crises. This contribution provides a comprehensive empirical (re-)assessment of the effectiveness of the ‘interest rate defense’. While I find evidence for some of the adverse channels that might undermine its effectiveness, interest rate defense emerges as a largely effective policy.; In Chapter 1 I survey the issues, and introduce an analytical framework which recognizes the ‘feedback effect’ nature of the theoretical hypotheses that try to explain the perceived underperformance of interest rate defense. I suggest a new yardstick for policy efficiency based on the size of these feedback effects.; In Chapter 2 I take a more comprehensive look at the stylized facts, using a large sample of currency crisis episodes. Looking at a new set of policy variables, basic statistical techniques reveal a number of interesting relationships with the exchange rate outcome of currency crises, and with certain country characteristics.; Chapter 3 then lays out a structural empirical model which captures explicitly the response of a given country's macroeconomic environment (especially interest rates) to speculative pressure, following the analytical approach presented in Chapter 1. It permits to gage the effectiveness of interest rate defense based on the system's dynamic response to speculative pressure with the feedback effects ‘turned off’.; In Chapters 4 and 5 I use this model to estimate feedback effects for a set of countries—Argentina, Hong Kong, Italy, Brazil and Turkey. I find statistically significant feedback effects for emerging economies in the sample—Argentina, Turkey and Brazil. Interestingly, feedback effects do not seem to be associated with the exchange rate regime. Overall I find that they contribute little to the interest rate needed to counter a given amount of speculative pressure. Therefore, despite the presence of feedback effects in some of the countries, the interest rate defense remains an effective policy tool.