Co-movement and Causality between Nominal Exchange Rates and Interest Rate Differentials in BRICS Countries: A Wavelet Analysis

This study uses wavelet analysis to examine the co-movement and causality between exchange rates and interest rate differentials in the BRICS countries in the period from 1996M1 to 2015M9. Empirical results indicate that co-movement and causality between interest rate differentials and exchange rates vary across frequencies and evolve over time, and they are more pronounced during the period of the recent global financial crisis in these countries. In particular, in the short run, exchange rates and interest rate differentials often move together in BRICS countries. In the long run, positive causality runs from interest rate differentials to exchange rates in South Africa and Russia, while reverse causality between these features occurs in China, and in India and Brazil, there exist bidirectional causalities between interest rate differentials and exchange rates in different sub-periods. These findings provide important implications for monetary authorities, suggesting the adoption of suitable policies to maintain exchange rate fluctuations in a well-balanced range and thereby improve the effectiveness of monetary policy. Moreover, our findings may also help investors respond appropriately to avoid the risk of changes in exchange rates and interest rates.