This 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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Paper 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: Handle: RePEc:hhs:bofitp:2002_007
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