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I always understood that high interest rates in country A attract investors and cause the currency to appreciate. However, the interest rate parity theory suggests that high interest rates weaken a currency and currency arbitrage is impractical.

How can these theories be reconciled? Are they rival theories?

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  • $\begingroup$ "the interest rate parity theory suggests that high interest rates weaken a currency" Can you please back up this claim with a reference? $\endgroup$ – Giskard Jul 22 '19 at 13:33
  • $\begingroup$ Eg economics.stackexchange.com/questions/4914/… $\endgroup$ – anotherfred Jul 22 '19 at 13:36
  • $\begingroup$ I don't see which part says what you are claiming. Could you please quote it? $\endgroup$ – Giskard Jul 22 '19 at 13:57
  • $\begingroup$ I would soften the wording around interest rate parity to something like “For example, interest rate parity arguments suggest...”, and eliminate “arbitrage is impractical” (since arbitrage in FX markets is so easily implemented, opportunities don’t show up in practice). The other angle that needs to be specified is fixed/floating regimes; there are good reasons why hiking rates works to defend the value of a currency when there is a peg. $\endgroup$ – Brian Romanchuk Jul 22 '19 at 14:04

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