Raising or maintaining high interest rates under crisis conditions may so weaken the economy that it may destabilize the exchange rate, even causing it to depreciate further, by raising the risk premium or the probability of default on credit. As either view of the effects of interest rates on the exchange rate during crisis periods can be supported theoretically, the disagreement can be resolved only by empirical analysis. Two papers in the volume addressed this issue. However, their estimates imply that such an interest rate defense against speculative attacks requires extremely high interest rate levels. Because the effects may be economically insignificant or very small, the high interest rates needed to restore exchange rate stability are potentially very disruptive.
Capital controls provide an alternative policy response to capital flow reversals.
Proponents argue that curbs on capital outflows, particularly during crises, could prevent the sudden withdrawal of capital, allowing policymakers to avoid the uncomfortable choice of raising domestic interest rates or allowing the currency to depreciate sharply, both of which can be very costly. The jury is still out on the value and effectiveness of such controls. This collection of 11 papers provides a valuable contribution to ongoing research into understanding the causes and consequences of currency crises as well as the options available to policymakers. Ramon Moreno Senior Economist Mark Spiegel Research Advisor Reference Glick, R., R. Moreno, and M. Spiegel, eds. Financial Crises in Emerging Markets.