Asymmetric relationship between interest rates and exchange rates: Evidence from Turkey

This paper deals with the dynamic relationship between the interest rate and exchange rate using the data from the Turkish economy. Macroeconomic variables possess both asymmetric and non‐linear features; however, most of the empirical research relating to the dynamics of the exchange rate has been conducted only within a linear framework. Therefore, in this paper, a non‐linear autoregressive distributed lag (NARDL) model is used to explore asymmetrical relations in the long‐run. The pieces of evidence provided in this article show that an increase in the domestic interest rate has a more robust effect on the exchange rate compared to a decrease of the interest rate. The results further indicate that the impact of the domestic interest rate in the short‐run is different from their long‐run effects. The linear models which neglect asymmetric relation can yield misleading results by showing no relationship between the two variables in the long‐run. This paper shows that there is a robust and stable but asymmetric relationship between the interest rate and exchange rate in the long‐run.