Is There a Trade-off between Exchange Rate and Interest Rate Volatility? Evidence from an M-GARCH Model

António Portugal Duarte, João Andrade and Adelaide Duarte ()
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Adelaide Duarte: Faculty of Economics, University of Coimbra and GEMF, Portugal

No 2015-01, GEMF Working Papers from GEMF, Faculty of Economics, University of Coimbra

Abstract: One of the main implications of the basic target zone model developed by Krugman (1991) is that there is a trade-off between exchange rate volatility and interest rate differential volatility. Using an M-GARCH model we find evidence that such a trade-off existed, prior to the introduction of the euro, between the exchange rate and the interest rate differential among Portugal and Germany. This result reflects the increased credibility of the Portuguese monetary policy, due mainly to the modernisation of the banking and financial system and to the progress made in the disinflation process under an exchange rate target zone.

Keywords: Credibility; disinflation; M-GARCH; volatility and target zones. (search for similar items in EconPapers)
JEL-codes: C32 C51 F31 F41 G15 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2015-01
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Published in International Journal of Economics Sciences 1(1): 19-38, 2012.

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Journal Article: Is There a Trade-off between Exchange Rate and Interest Rate Volatility? Evidence from an M-GARCH Model (2012)
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