The Relationship Between Exchange Rates and Interest Rates: Evidence from the U.S. and Europe

Abstract

We analyze the relationship between exchange rates and interest rates for a sample of exchange rates between the U.S. dollar and the euro, as well as 10-year Treasury rates for both countries. The short-term relationship is modeled using ARMA, GARCH, and TGARCH models, and the study finds that the European 10-year Treasury bond has a significant effect on the exchange rate between the two countries while the U.S. 10-year Treasury bond does not have that effect. The long-term relationship is studied using the ARDL-ECM model, and the results show that between the U.S. 10-year Treasury rate, the European 10-year Treasury rate and the exchange rate during the financial crisis.