The Behavior of Real Interest Rates in Exchange-Rate-Based Stabilization Programs.

This paper examines the behavior of real interest rates at the inception of exchange-rate-based stabilization programs. The analysis is based on an optimizing model of a small open economy facing imperfect world capital markets. A reduction in the devaluation rate is shown to have a positive impact on real interest rates. By contrast, a program characterized by an initial reduction in the devaluation rate and a perceived future increase in government spending has an ambiguous effect--which depends in particular on the degree of credibility of the fiscal policy stance. Copyright 1998 by Blackwell Publishing Ltd