Exchange rate stabilization and IMF high interest rate policy: A critical reconsideration using a dynamic model

This paper examines whether the IMF high interest rate policy was suitable for crisis-ridden East Asian economies. Using an "overshoot" model similar to that of Dornbusch's (1976), it shows that this sort of policy might caus e an unnecessary deflationary adjusting process and have no effect on conta ining the real depreciation of exchange rates in the long run. The study al so demonstrates that Thai economic data coincides quite well with the model presented here. Finally, it points out that the high interest policy itsel f might provoke high risk-premium, the existence of which, in turn, justifi es the policy. This means that the policy has a self-fulfilling property. I n conclusion, a "one-size-fits-all" adaptation of high interest rate policy in a currency crisis is very dangerous in general, and was inappropriate f or East Asia. The desirable policy would have been to let currencies deprec iate and keep interest rates stable.