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Interest rates and exchange rates: Crisis-driven dynamics

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  • Casta, Martin

Abstract

We examine the exchange rate response to interest rate surprises using weekly local projections instrumented with high-frequency surprises (LP-IV) for the US, Euro Area, and UK. The weekly frequency preserves identification while mitigating temporal aggregation bias. We provide a decomposition of LP-IV impulse responses that expresses estimated effects as weighted averages of historical outcomes. While baseline estimates indicate immediate exchange rate appreciation following monetary contractions, the decomposition reveals that these responses are driven primarily by a small number of crisis episodes, most notably the Global Financial Crisis, underscoring pronounced state dependence in exchange rate dynamics.

Suggested Citation

  • Casta, Martin, 2026. "Interest rates and exchange rates: Crisis-driven dynamics," Economics Letters, Elsevier, vol. 265(C).
    • Handle: RePEc:eee:ecolet:v:265:y:2026:i:c:s0165176526002235
    DOI: 10.1016/j.econlet.2026.113029
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    Keywords

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation

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