Nominal Exchange Rates and Nominal Interest Rate Differentials

Francisco Nadal De Simone and Weshah Razzak

No 1999/141, IMF Working Papers from International Monetary Fund

Abstract: This paper reexamines some unsettled theoretical and empirical issues regarding the relationship between nominal exchange rates and interest rate differentials and provides a model for the behavior of exchange rates in the long run, where interest rates are determined in the bond market. The model predicts that an increase in the interest rate differential appreciates the home currency. We test the model for the U.S. dollar against the Deutsche mark, the British pound, the Japanese yen, and the Canadian dollar. The first two pairs of exchange rates—for which purchasing power parity seems to hold—display a strong relationship with interest rate differentials.

Keywords: WP; exchange rate; Exchange rates; interest rate differential; bonds market; cointegration; common cycles; U.S. dollar; exchange rate-interest differential; interest rate differential CAD-USD; corresponding interest rate differential; nominal interest rate differential; differentials in the case; GBP-USD case; CAD-USD case; interest rate differential DM-USD; interest rate differential YEN-USD; differential CAD-USD; Real exchange rates; Real interest rates; Short term interest rates; Long term interest rates (search for similar items in EconPapers)
Pages: 41
Date: 1999-10-01
References: Add references at CitEc
Citations: View citations in EconPapers (11)

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