EXCHANGE RATE AND INTEREST RATE DIFFERENTIAL IN G7 ECONOMIES
Keywords:
G7 countries, asymmetry;, Structural break, Exchange rate, Interest rate differential
Abstract
We offer new insights on the dynamics of the exchange rate–interest rate differential
for the case of G7 economies. We show that the nexus is better considered using an
asymmetric model, as suggested by a host of previous studies. In addition, we find the
role of accounting for structural breaks to be prominent. We also show differences in the
nexus between euro and non-euro G7 countries, suggesting heterogeneous monetary
policies. Thus, we document the strongest evidence for the sticky price hypothesis in
Japan and lesser evidence in the euro countries and the United Kingdom, with Canada
consistently revealing evidence for the flexible price hypothesis.
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References
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of Finance, 18, 11-19.
Bahmani-Oskooee, M., and Aftab, M. (2017a). Asymmetric Effects of Exchange
Rate Changes on The Malaysia-EU Trade: Evidence from Industry Data.
Empirica, 44, 339–365.
Bahmani-Oskooee, M., and Aftab, M. (2017b). On the Asymmetric Effects of
Exchange Rate Volatility on Trade flows: New Evidence from US-Malaysia
Trade at the Industry Level. Econ. Modell, 63, 86–103.
Bahmani-Oskooee, M., and Kanitpong, T. (2017). Do Exchange Rate Changes Have
Symmetric or Asymmetric Effects on the Trade Balances of Asian Countries?.
Appl. Econ, 49,4668–4678.
Bahmani-Oskooee, M. and Motavallizadeh-Ardakani, A. (2018). Exchange Rate
Changes and Income Distribution in 41 Countries: Asymmetry Analysis. The
Quarterly Review of Economics and Finance, 68, 266-282.
Bautista, C.C. (2006). The Exchange Rate–Interest Differential Relationship in Six
East Asian Countries. Economics Letters, 92, 137-142.
Bianco, M.D., Camacho M. and Quiros, G.P. (2012). Short-Run Forecasting of
the Euro-Dollar Exchange Rates with Economic Fundamentals. Journal of
International Money and Finance, 31, 377–396.
Bilson, J. (1978). The Monetary Approach to the Exchange Rate – Some Empirical
Evidence. International Monetary Fund Papers, 25, 48-75.
Cheikh, N.B. and Zaied, Y.B. (2019). Revisiting the Pass-Through of Exchange
Rate in the Transition Economies: New Evidence from New EU Member
States. Journal of International Money and Finance, https://doi.org/10.1016/j.
jimonfin.2019.102093
Christodoulakis, G. and Mamatzakis, E. (2013). Behavioural Asymmetries in the
G7 Foreign Exchange Market. International Review of Financial Analysis, 29,
261–270.
Civcir, I. (2003). The Monetary Models of the Turkish Lira/U.S. Dollar Exchange
Rate: Long-Run Relationships, Short-Run Dynamics, and Forecasting. Eastern
European Economics, 41, 43-63.
Ding, L. and Yang, Q. (2017). Asymmetric Impact of Monetary Surprises on
Exchange Rate. Applied Economics, 50, 789-803.
Dornbusch, R. (1976). Expectations and Exchange Rate Dynamics. Journal of
Political Economy, 84, 1161–1176.
Frankel, J.A. (1979). On the Mark: A Theory Offloating Exchange Rates Based on
Real Interest Differentials. American Economic Review, 69, 610–622.
Frankel, J.A. (2014). On The Mark: A Theory of Floating Exchange Rates Based on
Real Interest Differentials. The American Economic Review, 69, 610-622.
Frenkel, J. (1976). A Monetary Approach to The Exchange Rate: Doctrinal Aspects
and Empirical Evidence. Scandinavian Journal of Economics, 78, 255-76.
Ghartey, E.E. (2018). Asymmetries in Exchange Rate Pass-Through and Monetary
Policy Principle: Some Caribbean Empirical Evidence. North American Journal
of Economics and Finance, 47, 325-335.
Hacker, R.S., Karlsson, H.K. and Månsson, K. (2013). An Investigation of The
Causal Relations Between Exchange Rates and Interest Rate Differentials
Using Wavelets. International Review of Economics and Finance, 29, 321-329.
Hanisch, M. (2019). US Monetary Policy and The Euro Area. Journal of Banking and
Finance, 100, 77–96.
Heimonen, K. (2009). The Euro–Dollar Exchange Rate and Equity Flows. Review of
Financial Economics, 18, 202–209.
Hooper, P. and Morton, J. (1982). Fluctuations in the Dollar: A Model of Nominal
and Real Exchange Rate Determination. Journal of International Money and
Finance, 1, 39–56.
Jackman, M., Craigwell, R., and Doyle-Lowe, M. (2013). Nonlinearity in the Reaction
of the Foreign Exchange Market to Interest Rate Differentials: Evidence from
A Small Open Economy With A Long-Term Peg. Applied Financial Economics,
23, 287-296
Kilian, L. and Taylor, M.P. (2003). Why Is It So Difficult to Beat the Random Walk
Forecast of Exchange Rates? Journal of International Economics, 60, 85–107.
Li, X. (2011). How Do Exchange Rates Co-Move? A Study on the Currencies of Five
Inflation-Targeting Countries. Journal of Banking & Finance, 35, 418–429.
Meese, R. and Rogoff, K. (1983). Empirical Exchange Rate Models of the Seventies:
Do They Fit Out of Sample? Journal of International Economics, 14, 3–24.
Moosa, I. (2013). Why Is It So Difficult to Outperform the Random Walk in
Exchange Rate Forecasting? Applied Economics, 45:23, 3340-3346.
Moosa, I., and Burns, K. (2014). Error Correction Modelling and Dynamic
Specifications as A Conduit to Outperforming the Random Walk in Exchange
Rate Forecasting. Applied Economics, 46, 3107-3118.
Narayan, P.K., and Liu, R. (2015). A Unit Root Model for Trending Time-Series
Energy Variables. Energy Econ. 50, 391–402.
Narayan, P.K. and Popp, S. (2010). A New Unit Root Test with Two Structural
Breaks in Level and Slope at Unknown Time. J. Appl. Stat., 37, 1425–1438.
Narayan, P.K. and Sharma, S.S. (2015). Does Data Frequency Matter for the Impact
of Forward Premium On Spot Exchange Rate? Int. Rev. Financ. Anal. 39, 45–53.
Ozcelebi, O. (2019). Assessment of Asymmetric Effects on Exchange Market
Pressure: Evidence from Emerging Countries. North American Journal of
Economics & Finance, 48, 498-513.
Özmen, M.U., and Yilmaz, E. (2017). Co-Movement of Exchange Rates with Interest
Rate Differential, Risk Premium and FED Policy in “Fragile Economies”.
Emerging Markets Review, 33, 173-188.
Rocha, M.D. (2012). Interest Rate Pass-Through in Portugal: Interactions,
Asymmetries and Heterogeneities. Journal of Policy Modeling, 34, 64–80.
Salisu, A.A. and Adeleke, A.I. (2016). Further Application of Narayan and Liu
(2015) Unit Root Model for Trending Time Series. Econ. Modell, 55, 305–314.
Salisu, A.A. and Ndako, U.B. (2018). Modelling Stock Price -Exchange Rate Nexus
in OECD Countries: A New Perspective. Economic Modelling, 74, 105-123.
Salisu, A.A., Adediran, I.A., Oloko, T.F. and Ohemeng, W. (2019). The Heterogeneous
Behaviour of the Inflation Hedging Property of Cocoa. North American Journal
of Economics and Finance, DOI: https://doi.org/10.1016/j.najef.2019.101093
Salisu, A.A., Ndako, U.B. and Oloko, T.F. (2019). Assessing the Inflation Hedging
of Gold and Palladium in OECD Countries. Resources Policy, 62, 357–377.
Shin, Y., Yu, B., and Greenwood-Nimmo, M. (2014). Modelling Asymmetric
Cointegrationand Dynamic Multipliers in An ARDL Framework. Horrace, W.C.
of Finance, 18, 11-19.
Bahmani-Oskooee, M., and Aftab, M. (2017a). Asymmetric Effects of Exchange
Rate Changes on The Malaysia-EU Trade: Evidence from Industry Data.
Empirica, 44, 339–365.
Bahmani-Oskooee, M., and Aftab, M. (2017b). On the Asymmetric Effects of
Exchange Rate Volatility on Trade flows: New Evidence from US-Malaysia
Trade at the Industry Level. Econ. Modell, 63, 86–103.
Bahmani-Oskooee, M., and Kanitpong, T. (2017). Do Exchange Rate Changes Have
Symmetric or Asymmetric Effects on the Trade Balances of Asian Countries?.
Appl. Econ, 49,4668–4678.
Bahmani-Oskooee, M. and Motavallizadeh-Ardakani, A. (2018). Exchange Rate
Changes and Income Distribution in 41 Countries: Asymmetry Analysis. The
Quarterly Review of Economics and Finance, 68, 266-282.
Bautista, C.C. (2006). The Exchange Rate–Interest Differential Relationship in Six
East Asian Countries. Economics Letters, 92, 137-142.
Bianco, M.D., Camacho M. and Quiros, G.P. (2012). Short-Run Forecasting of
the Euro-Dollar Exchange Rates with Economic Fundamentals. Journal of
International Money and Finance, 31, 377–396.
Bilson, J. (1978). The Monetary Approach to the Exchange Rate – Some Empirical
Evidence. International Monetary Fund Papers, 25, 48-75.
Cheikh, N.B. and Zaied, Y.B. (2019). Revisiting the Pass-Through of Exchange
Rate in the Transition Economies: New Evidence from New EU Member
States. Journal of International Money and Finance, https://doi.org/10.1016/j.
jimonfin.2019.102093
Christodoulakis, G. and Mamatzakis, E. (2013). Behavioural Asymmetries in the
G7 Foreign Exchange Market. International Review of Financial Analysis, 29,
261–270.
Civcir, I. (2003). The Monetary Models of the Turkish Lira/U.S. Dollar Exchange
Rate: Long-Run Relationships, Short-Run Dynamics, and Forecasting. Eastern
European Economics, 41, 43-63.
Ding, L. and Yang, Q. (2017). Asymmetric Impact of Monetary Surprises on
Exchange Rate. Applied Economics, 50, 789-803.
Dornbusch, R. (1976). Expectations and Exchange Rate Dynamics. Journal of
Political Economy, 84, 1161–1176.
Frankel, J.A. (1979). On the Mark: A Theory Offloating Exchange Rates Based on
Real Interest Differentials. American Economic Review, 69, 610–622.
Frankel, J.A. (2014). On The Mark: A Theory of Floating Exchange Rates Based on
Real Interest Differentials. The American Economic Review, 69, 610-622.
Frenkel, J. (1976). A Monetary Approach to The Exchange Rate: Doctrinal Aspects
and Empirical Evidence. Scandinavian Journal of Economics, 78, 255-76.
Ghartey, E.E. (2018). Asymmetries in Exchange Rate Pass-Through and Monetary
Policy Principle: Some Caribbean Empirical Evidence. North American Journal
of Economics and Finance, 47, 325-335.
Hacker, R.S., Karlsson, H.K. and Månsson, K. (2013). An Investigation of The
Causal Relations Between Exchange Rates and Interest Rate Differentials
Using Wavelets. International Review of Economics and Finance, 29, 321-329.
Hanisch, M. (2019). US Monetary Policy and The Euro Area. Journal of Banking and
Finance, 100, 77–96.
Heimonen, K. (2009). The Euro–Dollar Exchange Rate and Equity Flows. Review of
Financial Economics, 18, 202–209.
Hooper, P. and Morton, J. (1982). Fluctuations in the Dollar: A Model of Nominal
and Real Exchange Rate Determination. Journal of International Money and
Finance, 1, 39–56.
Jackman, M., Craigwell, R., and Doyle-Lowe, M. (2013). Nonlinearity in the Reaction
of the Foreign Exchange Market to Interest Rate Differentials: Evidence from
A Small Open Economy With A Long-Term Peg. Applied Financial Economics,
23, 287-296
Kilian, L. and Taylor, M.P. (2003). Why Is It So Difficult to Beat the Random Walk
Forecast of Exchange Rates? Journal of International Economics, 60, 85–107.
Li, X. (2011). How Do Exchange Rates Co-Move? A Study on the Currencies of Five
Inflation-Targeting Countries. Journal of Banking & Finance, 35, 418–429.
Meese, R. and Rogoff, K. (1983). Empirical Exchange Rate Models of the Seventies:
Do They Fit Out of Sample? Journal of International Economics, 14, 3–24.
Moosa, I. (2013). Why Is It So Difficult to Outperform the Random Walk in
Exchange Rate Forecasting? Applied Economics, 45:23, 3340-3346.
Moosa, I., and Burns, K. (2014). Error Correction Modelling and Dynamic
Specifications as A Conduit to Outperforming the Random Walk in Exchange
Rate Forecasting. Applied Economics, 46, 3107-3118.
Narayan, P.K., and Liu, R. (2015). A Unit Root Model for Trending Time-Series
Energy Variables. Energy Econ. 50, 391–402.
Narayan, P.K. and Popp, S. (2010). A New Unit Root Test with Two Structural
Breaks in Level and Slope at Unknown Time. J. Appl. Stat., 37, 1425–1438.
Narayan, P.K. and Sharma, S.S. (2015). Does Data Frequency Matter for the Impact
of Forward Premium On Spot Exchange Rate? Int. Rev. Financ. Anal. 39, 45–53.
Ozcelebi, O. (2019). Assessment of Asymmetric Effects on Exchange Market
Pressure: Evidence from Emerging Countries. North American Journal of
Economics & Finance, 48, 498-513.
Özmen, M.U., and Yilmaz, E. (2017). Co-Movement of Exchange Rates with Interest
Rate Differential, Risk Premium and FED Policy in “Fragile Economies”.
Emerging Markets Review, 33, 173-188.
Rocha, M.D. (2012). Interest Rate Pass-Through in Portugal: Interactions,
Asymmetries and Heterogeneities. Journal of Policy Modeling, 34, 64–80.
Salisu, A.A. and Adeleke, A.I. (2016). Further Application of Narayan and Liu
(2015) Unit Root Model for Trending Time Series. Econ. Modell, 55, 305–314.
Salisu, A.A. and Ndako, U.B. (2018). Modelling Stock Price -Exchange Rate Nexus
in OECD Countries: A New Perspective. Economic Modelling, 74, 105-123.
Salisu, A.A., Adediran, I.A., Oloko, T.F. and Ohemeng, W. (2019). The Heterogeneous
Behaviour of the Inflation Hedging Property of Cocoa. North American Journal
of Economics and Finance, DOI: https://doi.org/10.1016/j.najef.2019.101093
Salisu, A.A., Ndako, U.B. and Oloko, T.F. (2019). Assessing the Inflation Hedging
of Gold and Palladium in OECD Countries. Resources Policy, 62, 357–377.
Shin, Y., Yu, B., and Greenwood-Nimmo, M. (2014). Modelling Asymmetric
Cointegrationand Dynamic Multipliers in An ARDL Framework. Horrace, W.C.
Published
2019-10-28
How to Cite
Golit, P., Salisu, A., Akintola, A., Nsonwu, F., & Umoren, I. (2019). EXCHANGE RATE AND INTEREST RATE DIFFERENTIAL IN G7 ECONOMIES. Buletin Ekonomi Moneter Dan Perbankan, 22(3), 263-286. https://doi.org/10.21098/bemp.v22i3.1147
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