Skip to main content
SpringerLink
Log in

Exchange Rate Behavior of Canada, Japan, the United Kingdom and the United States

  • Research Article
  • Published:
Open Economies Review Aims and scope Submit manuscript

Abstract

We revisit a significant research topic on exchange rate behavior by restating the test procedures with an appropriate econometric methodology to re-examine three aspects. (i) Does the inflation (price) factor affect nominal exchange rate? (ii) Do relative interest rates affect a country’s exchange rate? (iii) Do the price and interest rate effects hold if controls for non-parity factors are embedded in tests? The quarterly data series for this study are taken over 55 years. The traditional parity condition model with price and interest rate as criterion variables is extended to take into account recently-verified non-parity factors, namely trade, productivity and foreign reserves. The results affirm that both parity factors and also the non-parity factors significantly affect the exchange rates of Canada, Japan, the United Kingdom and the United States. In our view, these findings relating to four free-floating currencies help extend our knowledge on how currency behavior is consistent with parity and non-parity theorems using a relevant methodological approach in this study.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Subscribe and save

Springer+ Basic
$34.99 /Month
  • Get 10 units per month
  • Download Article/Chapter or eBook
  • 1 Unit = 1 Article or 1 Chapter
  • Cancel anytime
Subscribe now

Buy Now

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. See Camarero & Tamarit (1996).

  2. The model has included a variable for inflation as the ln on CPI. Hence, using nominal relative interest rate in the test for IFE would mean that the inflation factor is again included in the second variable. To rectify this, we subtracted the expected inflation from the domestic and the foreign current nominal interest rates so that we test the IFE on the real interest rates.

  3. An anonymous reviewer commented that there could be structural breaks in the time series. The results reported are not likely to suffer from systematic effect of such possible breaks. Several breaks may exist, the combined effect of all of them is likely to be minimal since we used pooled mean group method, which allows for heterogeneity, intercept, slope coefficient and error variances, all of which would limit the effect of structural break in our final results.

  4. An anonymous reviewer commented that the paper has not considered a tax effect from interest rate, which yield incomes subjected to taxes. We are grateful for this comment. Perhaps extending our models in a newer direction may help to extend this current research further into tax effect study as a separate research.

References

  • Bahmani-Oskooee M, Kutan AM, Zhou S (2009) Towards solving the PPP puzzle: evidence from 113 countries. Appl Econ 41(24):3057–3066

    Article  Google Scholar 

  • Breusch TS (1978) Testing for autocorrelation in dynamic linear models. Aust Econ Pap 17(31):334–355

    Article  Google Scholar 

  • Breusch TS, Pagan AR (1979) A simple test for heteroscedasticity and random coefficient variation. Econometrica: J Econ Soc 1287–1294

  • Calvo GA, Izquierdo A, Talvi E (2003) Sudden stops, the real exchange rate, and fiscal sustainability: Argentina’s lessons: National Bureau of Economic Research

  • Camarero M, Tamarit C (1996) Cointegration and the PPP and the UIP hypotheses: An application to the Spanish integration in the EC. Open Econ Rev 7(1):61–76

    Article  Google Scholar 

  • Canarella G, Miller SM, Pollard SK (2014) Purchasing Power Parity Between the UK and Germany: The Euro Era. Open Econ Rev 25(4):677–699

    Article  Google Scholar 

  • Cassel G (1918) Abnormal deviations in international exchanges. Econ J 28(112):413–415

    Article  Google Scholar 

  • Cumby RE, Obstfeld M (1981) A Note on Exchange‐Rate Expectations and Nominal Interest Differentials: A Test of the Fisher Hypothesis. J Financ 36(3):697–703

    Article  Google Scholar 

  • Darby MR (1975) The financial and tax effects of monetary policy on interest rates. Econ Inq 13(2):266–276

    Article  Google Scholar 

  • Dickey DA, Fuller WA (1981) Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica: Journal of the Econometric Society 1057–1072

  • Dimitriou D, Simos T (2013) Testing purchasing power parity for Japan and the US: A structural-break approach. Jpn World Econ 28:53–59

    Article  Google Scholar 

  • Dornbusch R (1976) Expectations and Exchange Rate Dynamics. J Polit Econ 84(6):1161–1176

    Article  Google Scholar 

  • Edison HJ (1987) Purchasing power parity in the long run: A test of the dollar/pound exchange rate (1890–1978). J Money, Credit and Banking 19(3):376–387

    Article  Google Scholar 

  • Edison HJ, Melick WR (1999) Alternative approaches to real exchange rates and real interest rates: three up and three down. Int J Finance Econ 4(2):93–111

    Article  Google Scholar 

  • Edison HJ, Pauls BD (1993) A re-assessment of the relationship between real exchange rates and real interest rates: 1974–1990. J Monet Econ 31(2):165–187

    Article  Google Scholar 

  • Fama E (1984) Forward and spot exchange rates. J Monet Econ 14:319–338

    Article  Google Scholar 

  • Feldstein M (1976) On the theory of tax reform. J Public Econ 6(1):77–104

    Article  Google Scholar 

  • Fisher I (1930) The theory of interest. Macmillan, New York

    Google Scholar 

  • Frankel JA, Rose AK (1996) Currency crashes in emerging markets: An empirical treatment. J Int Econ 41(3):351–366

    Article  Google Scholar 

  • Frenkel JA (1976) A monetary approach to the exchange rate: doctrinal aspects and empirical evidence. The Scandinavian J Econ 200–224.

  • Godfrey LG (1978) Testing against general autoregressive and moving average error models when the regressors include lagged dependent variables. Journal of the Econometric Society, Econometrica, pp 1293–1301

    Google Scholar 

  • Gregory AW, Hansen BE (1996) Residual-based tests for cointegration in models with regime shifts. J Econ 70(1):99–126

    Article  Google Scholar 

  • Hall SG, Hondroyiannis G, Kenjegaliev A, Swamy P, Tavlas GS (2013) Is the relationship between prices and exchange rates homogeneous? J Int Money Financ 37:411–438

    Article  Google Scholar 

  • Hatemi-J A (2008) Tests for cointegration with two unknown regime shifts with an application to financial market integration. Empir Econ 35(3):497–505

    Article  Google Scholar 

  • Hill CH (Ed.) (2004) International business: Competing in the global marketplace (5 ed.). McGraw-Hill College

  • Ho CSF, Ariff M (2012) Time to equilibrium in exchange rates: G-10 and Eastern European economies. Global Finance J 23(2):94–107

    Article  Google Scholar 

  • Holmes MJ (2008) Real exchange rate stationarity in Latin America and relative purchasing power parity: A regime switching approach. Open Econ Rev 19(2):261–275

    Article  Google Scholar 

  • Im KS, Pesaran MH, Shin Y (1995) Testing for unit roots in heterogeneous panels Working Paper: Cambridge University

  • Johansen SR, Juselius K (1992) Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK. J Econ 53(1–3):211–244

    Article  Google Scholar 

  • Kao C, Chiang M-H (2001) On the estimation and inference of a cointegrated regression in panel data. Adv Econ 15:179–222

    Google Scholar 

  • Kim Y (2000) Causes of capital flows in developing countries. J Int Money Financ 19(2):235–253

    Article  Google Scholar 

  • Levin AT, Lin C-F (1992) Unit root tests in panel data: asymptotic and finite-sample properties: University of California at San Diego, Economics Working Paper Series

  • Lothian JR, Taylor MP (1996) Real exchange rate behavior: the recent float from the perspective of the past two centuries. J Polit Econ 488–509

  • Manzur M, Ariff M (1995) Purchasing power parity: new methods and extensions. Appl Financ Econ 5(1):19–26

    Article  Google Scholar 

  • Marini G, Piersanti G (2003) Fiscal deficits and currency crises. CEIS Tor Vergata-Research Paper Series(15)

  • Mark NC (1985) Some evidence on the international inequality of real interest rates. J Int Money Financ 4(2):189–208

    Article  Google Scholar 

  • Mark NC, Sul D (2003) Cointegration Vector Estimation by Panel DOLS and Long‐run Money Demand*. Oxf Bull Econ Stat 65(5):655–680

    Article  Google Scholar 

  • Martínez J (1999) Mexico’s balance of payments and exchange rates: a cointegration analysis. N Am J Econ Finance 10(2):401–421

    Article  Google Scholar 

  • Meese R, Rogoff K (1988) Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period. J Financ 43(4):933–948

    Article  Google Scholar 

  • Mishkin FS (1984) Are Real Interest Rates Equal Across Countries? An Empirical Investigation of International Parity Conditions. J Financ 39(5):1345–1357

    Article  Google Scholar 

  • Mollick AV (1999) The real exchange rate in Brazil Mean reversion or random walk in the long run? Int Rev Econ Finance 8(1):115–126

    Article  Google Scholar 

  • Pedroni P (1999) Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors. Oxf Bull Econ Stat 61(S1):653–670

    Article  Google Scholar 

  • Pedroni P (2004) Panel Cointegration: Asymptotic and Finite Sample Properties of Pooled Time Series Tests with an Application to the PPP Hypothesis. Econometric Theory 20(3):597–625

    Article  Google Scholar 

  • Pesaran MH, Smith R (1995) Estimating long-run relationships from dynamic heterogeneous panels. J Econ 68(1):79–113

    Article  Google Scholar 

  • Pesaran MH, Shin Y, Smith RP (1999) Pooled mean group estimation of dynamic heterogeneous panels. J Am Stat Assoc 94(446):621–634

    Article  Google Scholar 

  • Phillips PC, Perron P (1988) Testing for a unit root in time series regression. Biometrika 75(2):335–346

    Article  Google Scholar 

  • Ramsey JB (1969) Tests for specification errors in classical linear least-squares regression analysis. J Royal Statistical Soc. Series B (Methodological) 350–371

  • Rivera‐Batiz FL, Rivera‐Batiz LA (2001) International financial liberalization, capital flows, and exchange rate regimes: an introduction. Rev Int Econ 9(4):573–584

    Article  Google Scholar 

  • Rogoff K (1996) The purchasing power parity puzzle. J Econ Lit 34(2):647–668

    Google Scholar 

  • Shively PA (2001) A test of long-run purchasing power parity. Econ Lett 73(2):201–205

    Article  Google Scholar 

  • Stock JH, Watson MW (1993) A simple estimator of cointegrating vectors in higher order integrated systems. Journal of the Econometric Society, Econometrica, pp 783–820

    Google Scholar 

  • Throop AW (1993) A generalized uncovered interest parity model of exchange rates Economic Review (Vol. 2, pp. 3–16). Federal Reserve Bank of San Francisco

Download references

Acknowledgment

We are grateful to Law Siong Hook for clarifying to us issues of methodology for this study: Karam Shaar provided very useful research assistance. An earlier version of the paper was presented and received useful comments from discussant/participants at the World Banking and Finance Symposium in Singapore, 11–12 December, 2014. The revised paper incorporates amendments and further test results in response to comments from the Editor-in-Chief and two anonymous reviewers of the Journal. The authors take sole responsibility for errors. We acknowledge with thanks the Editor-in-Chief, George S. Tavlas and two anonymous referees for providing insightful comments and directions for revision of the earlier manuscript submitted to the Journal.

Author information

Authors and Affiliations

  1. Faculty of Economics and Management, University Putra Malaysia UPM, 43400, Serdang, Selangor, Malaysia

    M. Ariff

  2. Sunway University, No.5 Jalan Universiti, 47500, Bandar Sunway, Selangor, Malaysia

    A. Zarei

Authors
  1. M. Ariff
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. A. Zarei
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to M. Ariff.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Ariff, M., Zarei, A. Exchange Rate Behavior of Canada, Japan, the United Kingdom and the United States. Open Econ Rev 27, 341–357 (2016). https://doi.org/10.1007/s11079-015-9372-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11079-015-9372-x

Keywords

JEL Classification

Search

Navigation