Do Interest Rate and Inflation Matter for Exchange Rate Fluctuation in Bangladesh? An ARDL Approach

Abstract

This research explores the effects of inflation and interest rate on the nominal exchange rate in Bangladesh using data from 1980 to 2021. The Augmented Dicky-Fuller (ADF) test is used to find the order of integration whereas the ARDL approach has been used to determine the causality and cointegration among the variables. The ARDL bounds testing approach revealed a stable and statistically significant long-run relationship between Interest Rate (IR), Inflation (INF) and Exchange Rate (ER). The long-run ARDL model advocates that an increase in the lending interest rate leads to a significant appreciation of Bangladeshi currency in terms of USD. At the same time, the inflation has a positive but insignificant impact on the exchange rate at 5% level of significance. In the short-run, the effects of the interest rate on the exchange rate are positive and significant but the inflationary effect on the exchange rate is not statistically significant. Hence, the study recommends an efficient management of interest rate and inflation in Bangladesh to keep balance in the exchange rate.