Do high interest rates deter speculative attacks? – Evidence and some theory

This paper presents the first empirical evidence on the efficacy of raising interest rates ex ante as a deterrent to speculative attacks. Using a dataset that covers 54 countries from March 1964 through December 2005, we find strong evidence that raising interest rates in advance has significantly different impacts in different country groups. It significantly reduces the probability of attacks in countries that have a de facto hard peg but increases it in de facto soft-pegging countries. This finding is robust to alternative measure of monetary policy and to different specifications and samples. We then present a simple two-stage signaling model to offer a theoretical explanation for our empirical findings.