Co-determination of exchange rate and interest rate



This clip shows how interest rates — determined in national financial markets — and exchange rates — determined in the foreign exchange market — interact.

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Co-determination of exchange rate and interest rate

This clip shows how interest rates -- determined in national financial markets -- and exchange rates -- determined in the foreign exchange market -- interact. When the central bank changes the interest rate, it affects the no-arbitrage condition in the foreign exchange market: Given a constant "fundamental" expected exchange rate, the current exchange rate depreciates (rises) following a decrease of the domestic interest rate. Vice versa, the current exchange rate appreciates (falls) following an increase in the domestic interest rate.