The Exchange Rate and Interest Rate Differential Relationship: Evidence from Two Financial Crises

This paper examines the contemporaneous and inter-temporal interaction between real exchange rate and real interest rate differential in the two financial crises of 1997 and 2008 by using data from thirteen countries from different world regions. The empirical result shows that negative contemporaneous relationship exists in most countries. In addition, there is little evidence on a systematic inter-temporal relationship between the real interest rate differential and the real exchange rate, and an absence of consistent result in supporting a negative relationship among the thirteen economies. An extremely low change in the conditional correlation between real interest rate differential and real exchange rates can be found in small countries.