Exploring the Causal Relationship Between Interest Rate Differential and Exchange Rates of China and The U.S.: Frequency Domain Approach

Danhua Yan

doi:10.62051/kdnejw39

Authors

Danhua Yan

DOI:

https://doi.org/10.62051/kdnejw39

Keywords:

Interest rate differential; exchange rate; cointegration test; frequency causality test.

Abstract

In recent years, China has been actively opening up and internationalizing its financial markets, so it is meaningful to study the relationship between the interest rate differential and exchange rate between China and the United States. This study uses the data from January 1996 to September 2015 to investigate the linkage between the interest rate differential and the exchange rate of the RMB between China and the United States using frequency causality test. Theoretically, interest rate differential and exchange rates should have Granger causality, but the empirical results show that there is no long-run relationship of cointegration between the China-U.S. interest rate differential and the RMB exchange rates in the cointegration test. In the frequency causality test, it is found that the RMB exchange rate has a long-run and medium-run unidirectional causality on the China-US interest rate differential, while the China-U.S. interest rate differential does not have long-run, medium-run and short-run frequency causality on the RMB exchange rate.

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