Interpreting Currency Movements During the Crisis: What's the Role of Interest Rate Differentials?

45 Pages Posted: 1 Feb 2011

See all articles by Nicoletta Batini

Nicoletta Batini

International Monetary Fund (IMF)

Thomas Dowling

International Monetary Fund (IMF) - Western Hemisphere Department

Date Written: Janurary 2011

Abstract

Using an adaptation of the Uncovered Interest Parity (UIP) condition, this paper analyzes the drivers behind the large, symmetric exchange rate swings observed during the financial crisis of 2008-2010. Employing a Nelson-Siegel model, we estimate yield curves and decompose the exchange rate movements into changes we attribute to monetary policy and a residual. We find that the depreciation phase of the currencies in our sample was largely dominated by safe-haven effects rather than carry trade activity or other return considerations. For some countries, however, the appreciation that began at the end of 2008 seems largely to reflect downward movement in the cumulative revisions to nominal forward differentials, suggesting carry trade.

Keywords: Currencies, Developed countries, Economic models, Emerging markets, Exchange rate adjustments, Exchange rates, Financial crisis, Global Financial Crisis 2008-2009, Interest rates, Monetary policy

Suggested Citation

Batini, Nicoletta and Dowling, Thomas, Interpreting Currency Movements During the Crisis: What's the Role of Interest Rate Differentials? (Janurary 2011). IMF Working Papers, Vol. , pp. 1-44, 2011. Available at SSRN: https://ssrn.com/abstract=1751424

Nicoletta Batini

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Thomas Dowling

International Monetary Fund (IMF) - Western Hemisphere Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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