JOINT MOVEMENT BETWEEN JORDANIAN AND FOREIGN INTEREST RATES UNDER FIXED EXCHANGE RATE

Abstract

Interest rate by and large is one of the important economic variables which may have a significant impact on the economy. This study examines, in particular, the nature of the relationship between the local and foreign interest rates due to the fixed exchange rate between the Jordanian dinar and the U.S. dollar. In addition, it investigates the role of the relationship between interest rates with respect to the independence of monetary policy. Stationarity tests for two scenarios of the U.S. interest rates are used to verify the applicability of the theory of interest rate parity to the Jordanian economy. This theory includes an assumption of a joint movement between local and foreign interest rates. Cointegration test was also used to indicate the extent to which the two rates are cointegrated over the time. The results of stationarity of time-series test and their differences were contrary to the theory of interest rate parity that assumes a domestic interest rate is affected by the foreign interest rate. Thus, the results do not indicate a joint movement between the domestic and foreign interest rates in the long term. Despite this result, the study recommends maintaining an adequate margin between the rates of domestic and foreign interest, which allows the policy makers monetary independence.