question economics?

Question

The government of a small nation of Stabilia is overturned by a military coup. ( the new ruling junta restores the country's old name of Instabilia.) What would you expect to happen to Instabilia's real interest rate and real exchange rate?

Answer 1

Exchange rate of Instabilia currency to foreign currency will soar - no one wants money that might be worth nothing. Interest rates will soar - it's the only way banks can get people to deposit their new currency.

Answer 2

Depends on the reputation of the government and the reaction of the people.

There have been military coups welcomed by the populace because of government mismanagement, and under those circumstances real interest and exchange rates improved, at least until the military government wore out its welcome.

Then there have been those that were not welcomed, the economy was seen as becoming less stable and worse run, so real interest rates go up, etc. For example, see Burma:
http://en.wikipedia.org/wiki/Economy_of_Myanmar

Then there are such factors as to whether the U.S. recognizes the new government (the U.S. has backed many military coups and recognized many others) lending it legitimacy in the eyes of the markets, or whether the U.S. has disapproved of the coup.

For example, after the CIA backed the coup by General Pinochet against the elected government of Allende in 1973,
http://www.spartacus.schoolnet.co.uk/COLDchile.htm
interest rates and inflation went down. (Note the comments on "curbing inflation" in:
http://workmall.com/wfb2001/chile/chile_history_neoliberal_economics.html

Also check the Library of Congress report on Chile:
http://lcweb2.loc.gov/frd/cs/cltoc.html