Working Paper: NBER ID: w10280
Authors: Kenneth D. West
Abstract: The relationship between interest rates and exchange rates is puzzling and poorly understood. But under some standard assumptions, interest rates can be adjusted to smooth real exchange rate movements at the possible price of increased volatility in other variables. In New Zealand, estimates made under some generous suppositions about what monetary policy is able to accomplish suggest that decreasing real exchange rate volatility by about 25% would require increasing output volatility by about 10-15%, inflation volatility by about 0-15% and interest rate volatility by about 15-40%.
Keywords: Monetary policy; Exchange rates; Volatility
JEL Codes: E520; F310; F410
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| decreasing real exchange rate volatility (F31) | increase in output volatility (E39) |
| decreasing real exchange rate volatility (F31) | increase in inflation volatility (E31) |
| decreasing real exchange rate volatility (F31) | increase in interest rate volatility (E43) |
| interest rate changes (E43) | real exchange rate volatility (F31) |