Nominal Exchange Rates and Nominal Interest Rate Differentials

Author/Editor:

Francisco d Nadal De Simone ; Weshah Razzak

Publication Date:

October 1, 1999

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper reexamines some unsettled theoretical and empirical issues regarding the relationship between nominal exchange rates and interest rate differentials and provides a model for the behavior of exchange rates in the long run, where interest rates are determined in the bond market. The model predicts that an increase in the interest rate differential appreciates the home currency. We test the model for the U.S. dollar against the Deutsche mark, the British pound, the Japanese yen, and the Canadian dollar. The first two pairs of exchange rates—for which purchasing power parity seems to hold—display a strong relationship with interest rate differentials.

Series:

Working Paper No. 99/141

Subject:

English

Publication Date:

October 1, 1999

ISBN/ISSN:

9781451856163/1018-5941

Stock No:

WPIEA1411999

Format:

Paper

Pages:

41

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