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The Non--Monotonic Relationship between Interest Rates and Exchange Rates

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Author Info

  • Carlos Vegh

    (University of Maryland)

  • Amartya Lahiri

    (University of British Columbia)

  • Viktoria Hnatkovska

    (University of British Columbia)

Abstract

We calibrate the model to match the business cycle regularities of emerging economies. We then conduct policy experiments involving the domestic interest rate and demonstrate the central result of the paper: the relationship between interest rates and exchange rates is non-monotonic. We find that increases in the interest rate up to 35% both appreciate the currency and induce a fall in the rate of currency depreciation. However, more aggressive increases in the domestic interest rate both depreciate the currency as well as increase the rate of currency depreciation. Our results provide an explanation for the inability of non-structural empirical models to find a systematic relationship.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 1003.

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Date of creation: 2007
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Handle: RePEc:red:sed007:1003

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
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Web page: http://www.EconomicDynamics.org/society.htm
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Cited by:
  1. Javier Gómez, 2004. "Inflation Targeting and Sudden Stops," BORRADORES DE ECONOMIA 002854, BANCO DE LA REPÚBLICA.

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