Empirical Study on Impact of Interest Rate on Exchange Rate

Abstract

The World has become a Global Village that is evident from the fact that America’s economic crunch has adversely affected the economies of China, Japan, India and many other countries. The main question arises that what makes these economies dependent on each other or what are those macro-economic variables that affect these economies strappingly and their relationship with each other. This paper is an attempt to investigate the impact of interest rates on exchange rate of Pakistan and USA. For this purpose, historical data of Pak Rupee/USA Dollar exchange rate was collected along with their monthly interest rates. The relationship between interest rate differential and exchange rate differential of Pakistan and USA was studied by applying Simple Linear Regression Model. The empirical relationship between interest rate and exchange rate turned out to be positive. There was observed a non-significant impact of Interest rate differential on exchange rate differential that gives a direction for future research area to study other macro-economic variables and find out their impact on exchange rate independently and communally by using Multiple Regression Model.

Keywords: Interest Rate, Exchange Rate, Simple Linear Regression Model, Macro-Economic Variables

JEL Classification: C82