Economic activity, foreign exchange rate, and the interest rate during the Asian crisis

In a simple linear rational expectations model in which monetary authorities act to stabilize the exchange rate and also to mitigate adverse effects on real activity, a rise in interest rate is followed by exchange rate depreciation. In daily data across VAR and VECM models a rise in interest rate is associated with significant exchange rate depreciation for Thailand, the Philippines, and Korea. Depreciation and increases in the interest rate raise business failures that intensify crisis. Crisis management of the exchange rate must consider damaging effect of restrictive policy on financially constrained banking sector and non-financial firms.