IMF paper on interest rates/ currency pegs

This IMF working paper studies a policy often used to defend a currency peg: raising short-term interest rates. A key implication of the model is that an interest rate defense can always be successful, but has great costs for domestic agents. Hence, it says, governments are reluctant to sustain this policy for long periods of time.

The rationale for this policy is to stem demand for foreign reserves. Yet, this mechanism is absent from most monetary models. This paper develops a general

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