A study of the efficacy of interest rate defence against currency speculations : the case of HK

The pressure of depreciation during crisis period is always followed by a soaring interest rate. This interest rate defense launched by government is supposed to increase the cost of speculation and thus defend the local currency's exchange rate. In this paper, we use the historical data in Hong Kong during the Asian Financial Crisis to test whether this increased interest rate has effect of deterring speculation. I adopted two different definition of the speculative profit on forward currency market and observed that there are significant positive structural changes of two interest rate related variables. This regression results indicate that interest rate defense practiced by Hong Kong Monetary Authority during crisis period lost its efficacy of deterring speculation compared with non-crisis period. To make things worse, increased interest rate in HK during crisis period is much more possible to incur speculations. In consideration great negative impact on fiscal debt and financial institutions, etc, interest rate defense in HK failed in deterring speculators