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Does Interest Rate Still Matter in Determining Exchange Rate?

Author

Listed:
  • Wai-Mun Har

    (Faculty of Accountancy and Management, Universiti Tunku Abdul Rahman, Malaysia.)

  • Ai-Lian Tan

    (Faculty of Business and Finance, Universiti Tunku Abdul Rahman, Malaysia.)

  • Chong-Heng Lim

    (Faculty of Business and Finance, Universiti Tunku Abdul Rahman, Malaysia.)

  • Chai-Thing Tan

    (Faculty of Business and Finance, Universiti Tunku Abdul Rahman, Malaysia.)

Abstract

The interest rate plays an important role in determining the exchange rate in various economic theories. However, this has been challenged both conceptually and practically. The rapid development of global financial linkages makes many attractive non-interest-bearing investments available, which dwarf the profit opportunity from interest-bearing assets. The sensitivity of the exchange rate fluctuations and institutional factors also cast doubt on the role of the interest rate in determining the exchange rate. This research used nine Asian countries, five of which are ASEAN members (Thailand, Indonesia, Malaysia, Singapore, and the Philippines), the others being South Korea, Japan, India, and China. The sample period varied between 1994 and 2015. The results from the Pool Mean Group method show that the real effective real interest rate has a significant long-run negative association with the exchange rate. This implies that the interest rate does matter in determining the exchange rate.

Suggested Citation

  • Wai-Mun Har & Ai-Lian Tan & Chong-Heng Lim & Chai-Thing Tan, 2017. "Does Interest Rate Still Matter in Determining Exchange Rate?," Capital Markets Review, Malaysian Finance Association, vol. 25(1), pages 19-25.
    • Handle: RePEc:mfa:journl:v:25:y:2017:i:1:p:19-25
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    More about this item

    Keywords

    Interest rate; exchange rate; pool mean group; Asia.;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • N15 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - Asia including Middle East

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