The exchange rate as nominal anchor: A test for Ukraine

Transition economies, and especially those of the former Soviet Union, have used fixed exchange-rate policy as a nominal anchor for interest rates and inflation during recent decades. In this paper I demonstrate that the rigorous application of this policy in Ukraine over the period 1999–2005 did not in fact eliminate significant deviations of Ukrainian interbank interest rates from those on the London interbank market. Estimation using weekly data over the period 1999–2005 illustrates that the government’s “nominal anchor” policy vis à vis the US dollar was effective at eliminating the risk of currency depreciation. However, other risks related to convertibility and liquidity were either not addressed or exacerbated, and thus deviations from uncovered interest parity continued through the period. This has a clear policy implication: monetary and financial-sector policy should be coordinated to eliminate convertibility and liquidity risk as well as the risk of currency depreciation.