Interest rate autonomy in the presence of exchange rate stability: evidence from 13 selected Asia Pacific countries

Abstract

ABSTRACTA notable feature of the empirical research on the interest rate autonomy is that very few studies seek to determine whether the use of interest rate policy to fine-tune the exchange rate misalignments has been undermined by sterilised foreign exchange intervention. To overcome this deficiency, this study uses the open-economy Taylor rule as a policy reaction function in a standard macroeconomic model to specify the measures of independent interest rate policy reacts to the exchange rate and examines the empirical validity based on a sample of 13 selected Asia Pacific countries. Using the generalised method of moments, the findings provide some policy implications; the interest rate instrument can serve as a coordinating function to fine-tune the exchange rate misalignments for improving the macroeconomic stability and serve as an external shock absorber to avoid or mitigate impact of instability in the foreign capital market.