TAILIEUCHUNG - The Impact of Exchange Rate Regime on Interest Rates in Latin America*

Additionally, this positive association holds for interest-rate options contracts, forward contracts, and futures contracts, suggesting that banks using any form of these contracts, on average, experience significantly higher growth in their C&I loan portfolios. Furthermore, C&I loan growth is positively related to capital ratio and negatively related to C&I loan charge-offs. The findings in this study are confirmed after a robustness check. Examining the relationship between the C&I loan growth and derivative usage poses a potential endogeneity problem because the derivative-use decision and lending choices may be made simultaneously. To address this problem, an instrumental-variable approach is. | Cuadernos DE Economía Vol. 47 Mayo pp. 91-124 2010 The Impact of Exchange Rate Regime on Interest Rates in Latin America Caroiine Duburcq Université de la Méditerranée Aix-Marseille II We develop a theoretical framework to study the impact of the exchange rate regime in the interest rate determination. Using VECM we assess the role of both domestic conditions and US factors in the determination of eight Latin-American countries interest rates between February 1998 and April 2009. Three countries have hard-peg while the remaining five follow alternative regimes. The long and short-run determinants of domestic rates as well as an impulse response analysis prove that economies with rigidly-fixed exchange rates do not bear a loss of monetary autonomy substantially higher than that of floating-rate economies with the exception of Brazil. JEL E43 F31 C32 Keywords Interest Rate Determination Exchange Rate Regime Vector Error Correction Models 1. Introduction Choosing an exchange rate regime is a fundamental macroeconomic policy decision especially for small open economies. The choice to adopt fixed exchange rates or not may determine policy options and or the ability to maintain open capital markets. In this paper we test a basic proposition of international macroeconomics the notion of the open-economy trilemma Mundell 1963 which implies that countries cannot have fixed exchange rates domestic monetary autonomy and open capital markets all at once but can only pursue two of these options. We can explain the behavior of short-term interest rates with two different approaches Barassi et al 2005 . Interest rates can either be treated as analogous to other asset prices in which case their movements are interpreted as being I thank Eric Girardin as well as an anonymous referee for comments and suggestions which were very helpful in improving the present paper. Email 92 CuADERNOS DE EcONOMÍA Vol. 47 Mayo 2010 determined by financial flows in .

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