Co-movement of exchange rates with interest rate differential, risk premium and FED policy in “fragile economies”

Ozmen, Mustafa; Yılmaz, Erdal

doi:10.1016/j.ememar.2017.10.007

Cited by 29 publications

(14 citation statements)

References 41 publications

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“…Hacker et al (2014) find that nominal interest rate differential causes the exchange rate but they also find through impulse responses that there is a negative effect at lower wavelet scales. Özmen and Yılmaz (2017) incorporate the risk premium, monetary policy implementations and uncertainty into the analysis. This study for Turkey reveals a non-uniform relationship between interest rate and exchange rate.…”

Section: Theoretical Backgroundmentioning

confidence: 99%

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Capasso

Napolitano

Jiménez

2019

JES

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Purpose The purpose of this paper is to analyse the long-term nature of the interrelationship between interest rate and exchange rate. Design/methodology/approach By employing Mexican data, the authors estimate a non-linear autoregressive distributed lags (NARDL) model to investigate the nature of the changes and the interaction between interest rate and exchange rate in response to monetary authorities’ actions. Findings The results show that, contrary to simplistic predictions, the real exchange rate causes the real interest rate in an asymmetric way. The bounds testing approach of the NARDL models suggests the presence of co-integration among the variables and the exchange rate variations appear to have significant long-run effects on the interest rate. Most importantly, these effects are asymmetric and positive variations in the exchange rate have a lower impact on the interest rate. It is also interesting to report that the reverse is not true: the interest rate in the long-run exerts no statistical significant impact on the exchange rate. Practical implications The asymmetric long-term relationship between real exchange rate and real interest rate is evidence of why monetary authorities are reluctant to free float exchange rate. In Mexico, as in most developing countries, monetary policy strongly responds to exchange rate movements because these have relevant effects on commercial trade. Moreover, in dollarized economies these effects are stronger because of pass-through impacts to inflation, income distribution and balance-sheet equilibrium (the well-known “original sin”). Originality/value Under inflation targeting and flexible exchange rate regime, despite central banks pursue the control of short-term interest rate, in the long-run one could observe that it is the exchange rate that influences the interest rate, and that this reverse causality is stronger in emerging economies. This paper contributes by analysing the asymmetric relationship between the variables.

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Section: Theoretical Backgroundmentioning

confidence: 99%

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Capasso

Napolitano

Jiménez

2019

JES

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“…Models of the exchange rate-interest rate differential are not new in the literature, studies exploring the diverse theoretical models (e.g., Bautista, 2006;Hacker et al, 2013;Frankel, 2014;Moosa and Burns, 2014;Andries et al, 2017;Özmen and Yilmaz, 2017) are far from conclusive, and various assumptions of an open economy continue to lead to different conclusions. Amidst these diversities, the unstable nature of the linear econometric modeling of the exchange rate and its fundamentals is brought to the fore by the burgeoning of empirical studies incorporating nonlinearities into the nexus (e.g., Christodoulakis and Mamatzakis, 2013;Ding and Yang, 2017;Bahmani-Oskooee and Motavallizadeh-Ardakani, 2018;Cheikh and Zaied, 2019).…”

Section: Introductionmentioning

confidence: 99%

Exchange Rate and Interest Rate Differential in G7 Economies

Golit¹,

Salisu

Akintola³

et al. 2019

BEMP

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We offer new insights on the dynamics of the exchange rate–interest rate differentialfor the case of G7 economies. We show that the nexus is better considered using anasymmetric model, as suggested by a host of previous studies. In addition, we find therole of accounting for structural breaks to be prominent. We also show differences in thenexus between euro and non-euro G7 countries, suggesting heterogeneous monetarypolicies. Thus, we document the strongest evidence for the sticky price hypothesis inJapan and lesser evidence in the euro countries and the United Kingdom, with Canadaconsistently revealing evidence for the flexible price hypothesis.

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“…In order to analyze the risk factors that the relationship with exchange rates and interest rates is opposed to, some indicators can be incorporated into the empirical analysis. In this respect, [11] adopted Credit Default Swaps Spreads (CDS) for bonds as a measure of risk premium into wavelet coherency analysis in order to investigate the relationship between the exchange rate changes and interest rates in emerging economies. It was revealed that exchange rates were related to interest rate differentials, risk premium, the FED's monetary policy implementation and its policy uncertainty.…”

Section: Literature Reviewmentioning

confidence: 99%

Impacts of Exchange Rate Volatility on Macroeconomic and Financial Variables: Empirical Evidence from PVAR Modeling

Özçelebi¹

2018

Trade and Global Market

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In this study, Panel Vector Autoregression (PVAR) models are used to determine the impacts of exchange rate volatility on industrial production growth rate, consumer price inflation, short-term interest rates and stock returns for 10 OECD countries. The variance decompositions (VDCs) found that exchange rate volatility can be a secondary factor for the variations in immediate interest rates, implying that Uncovered Interest Rate Parity (UIP) condition should be analyzed by the inclusion of other macroeconomic variables. Impulse response functions (IRFs) expose that volatility in exchange rates can have a positive impact on the liquidity conditions in money market and an increase in real economic activity because investors have to move their money away from currency markets to money markets. The relatively lower impact of exchange rate volatility may arise from the zero bound problem, thus it is emphasized that the examination of impacts on exchange rate volatility on macroeconomics variables should be made both considering conventional and unconventional monetary policy. Although impulse response functions (IRFs) did not detect the significant impact of exchange rate volatility on inflation, VDCs obtained supporting results to exchange rate pass-through (ERPT). I suggest that the monetary policy to be developed should clarify alternative channels that exchange rate may affect inflation.

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Co-movement of exchange rates with interest rate differential, risk premium and FED policy in “fragile economies”

Cited by 29 publications

References 41 publications

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Exchange Rate and Interest Rate Differential in G7 Economies

Impacts of Exchange Rate Volatility on Macroeconomic and Financial Variables: Empirical Evidence from PVAR Modeling

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