Real and Monetary Factors in the Joint Determination of the Exchange Rate and the Interest Rate

The paper analyzes the joint determination of the exchange rate and the interest rate in terms of the stochastic structure of underlying real and monetary factors. It argues that the information contained in the covariation of the exchange rate and the interest rate, as two variables that respond to the same economic disturbances, can be used to infer the nature of those disturbances underlying exchange rate determination. A statistically significant correlation between the exchange rate and the interest rate is shown to be inconsistent with the stochastic structure of underlying disturbances implied by the strictly random walk property of the exchange rate