When Low Rates Speak Loud: exchange rate dynamics under different interest rate regimes

This paper examines the relationship between interest rate differentials and exchange rate returns across different monetary regimes, with a particular focus on distinguishing between high- and low-interest-rate setups. Relying on a rich panel dataset comprising 46 countries and over two decades of monthly observations, we estimate panel models that allow for country-specific heterogeneity and regime-dependent dynamics. Thresholds separating regimes are constructed in a fully data-driven manner, including conditional and time-varying specifications. Our findings show that exchange rate elasticity with respect to interest rate differentials indeed depends on the regime and it is usually higher under low interest rates, a result consistent across several model specifications and robustness checks. A clustering analysis is also conducted to uncover groups of countries with similar FX dynamics, further highlighting the heterogeneous nature of currency responses across the international landscape.