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Co-Movements Between Foreign And Domestic Interest Rates In A Fixed Exchange Rate Regime: The Case Of The Eccu And The Us

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Author Info
GRENADE, Kari
MOORE, Winston ()

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Abstract

Economic theory posits that in a fixed exchange rate regime with unrestricted capital flows, domestic interest rates must track closely those of the country to which the currency is pegged. This paper empirically tests this theory by investigating the sensitivity of interest rates in the Eastern Caribbean Currency Union (ECCU) to changes in the US rates. The empirical results show long –run convergence between the two rates, indicating that interest rate parity holds for all countries in the ECCU. In the short–run, changes in the Fed funds rate have an almost immediate impact on lending rates and T-bill rates in the ECCU. The paper extends the empirical literature on the transmission of foreign interest rate changes and monetary policy independence in small open economies with fixed exchange rates.

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Publisher Info
Article provided by Euro-American Association of Economic Development in its journal Applied Econometrics and International Development.

Volume (Year): 8 (2008)
Issue (Month): 1 ()
Pages: 119-130
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Handle: RePEc:eaa:aeinde:v:8:y:2008:i:1_10

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Related research
Keywords: Interest Rate Parity; Unit Roots; Interest Rate Adjustments; Fixed Exchange Rate; ECCU;

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  2. Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2004. "Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar period," NBER Working Papers 10393, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Fabio Busetti & Lorenzo Forni & Andrew Harvey & Fabrizio Venditti, 2006. "Inflation convergence and divergence within the European Monetary Union," Working Paper Series 574, European Central Bank. [Downloadable!]
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  4. Maurice Obstfeld & Jay Shambaugh & Alan Taylor, 2004. "The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility," International Finance 0407003, EconWPA. [Downloadable!]
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  5. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July. [Downloadable!] (restricted)
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  6. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November. [Downloadable!] (restricted)
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  7. Choi, In, 2001. "Unit root tests for panel data," Journal of International Money and Finance, Elsevier, vol. 20(2), pages 249-272, April. [Downloadable!] (restricted)
  8. Winston Moore & Roland Craigwell, 2002. "Market Power and Interest Rate Spreads in the Caribbean," International Review of Applied Economics, Taylor and Francis Journals, vol. 16(4), pages 391-405, October. [Downloadable!] (restricted)
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  10. Harvey, A. & Bates, D., 2003. "Multivariate Unit Root Tests and Testing for Convergence," Cambridge Working Papers in Economics 0301, Faculty of Economics, University of Cambridge. [Downloadable!]
  11. Frankel, Jeffrey & Schmukler, Sergio L. & Serven, Luis, 2004. "Global transmission of interest rates: monetary independence and currency regime," Journal of International Money and Finance, Elsevier, vol. 23(5), pages 701-733, September. [Downloadable!] (restricted)
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  12. Naka, Atsuyuki & Tufte, David R, 1997. "Examining Impulse Response Functions in Cointegrated Systems," Applied Economics, Taylor and Francis Journals, vol. 29(12), pages 1593-1603, December. [Downloadable!] (restricted)
  13. Maddala, G S & Wu, Shaowen, 1999. " A Comparative Study of Unit Root Tests with Panel Data and a New Simple Test," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 631-52, Special I. [Downloadable!] (restricted)
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  15. Antzoulatos, Angelos A., 2002. "Benchmark Yield Undershooting in the E.M.U," Discussion Paper Series 26207, Hamburg Institute of International Economics. [Downloadable!]
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  17. Kaddour Hadri, 2000. "Testing for stationarity in heterogeneous panel data," Econometrics Journal, Royal Economic Society, vol. 3(2), pages 148-161.
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