Financial contagion, interest rates and the role of the exchange rate as shock absorber in Central and Eastern Europe
AbstractThis paper studies the impact of external factors on daily exchange rates and short-term interest rates in the Czech Republic, Hungary and Poland during the period August 1997 – May 2001. I find that neither exchange rates nor interest rates are influenced by short-term German interest rates. Nevertheless, I show that shocks to emerging-market risk premia had a significant impact on exchange rates in all three Central and Eastern European countries and on interest rates in the Czech Republic. In addition, studying the second moment of the variables, I demonstrate that Czech and Polish exchange rates were affected by ‘volatility contagion’ coming from emerging markets. I find also some partial support for the ‘volatility contagion’ hypothesis on Czech interest rates. These findings shed some doubts on the alleged theoretical ability of a floating exchange rate – such as in the Czech Republic – to absorb external shocks and insulate a country's domestic monetary policy completely. However, the spill-over effect on Czech interest rates might be explained by the ‘managed’ nature of the exchange rate regime, thereby re-establishing some credibility of the theory.
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Bibliographic InfoPaper provided by Bank of Finland, Institute for Economies in Transition in its series BOFIT Discussion Papers with number 7/2002.
Length: 46 pages
Date of creation: 11 Jul 2002
Date of revision:
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Postal: Bank of Finland, BOFIT, P.O. Box 160, FI-00101 Helsinki, Finland
Phone: + 358 10 831 2268
Fax: + 358 10 831 2294
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exchange rates; short-term interest rates; volatility; Czech Republic; Hungary; Poland;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-09-16 (All new papers)
- NEP-EEC-2007-09-16 (European Economics)
- NEP-MAC-2007-09-16 (Macroeconomics)
- NEP-MON-2007-09-16 (Monetary Economics)
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