Asymmetric and Time-Varying Behavior of Exchange Rate and Interest Rate Differential in Emerging Markets

This study assesses the nonlinearities in the nexus between exchange rate and interest rate differential in emerging economies of BRICS. We employ Panel Nonlinear Autoregressive Distributed Lag and Panel Threshold Regression (PTR) models. The study finds mixed result for asymmetry in the nexus. It also shows evidence for time-variation and the positive impact of interest rate differential on exchange rate gradually increases at higher economic activity and inflation regime. The implication is that interest rate differential has both asymmetric and time-varying effects on exchange rate which partly explains the continuous adjustment of monetary policy rates in many emerging markets. Finally, the role of economic productivity and domestic price level in the response of exchange rate to interest rate differentials across the BRICS should not be jettisoned to realize plausible outcomes.