The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian Development Bank Institute (ADBI), the Asian
Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for
any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

Exchange Rate Behavior with

Negative Interest Rates:
Some Early Negative
Observations
Andrew K. Rose
Berkeley-Haas, ABFER, CEPR and NBER
(with Allaudeen Hameed)
 Motivation
In last decade, five economies experienced (non-trivial) negative
nominal interest rates
Denmark, EMU, Japan, Sweden, Switzerland
Most focus on consequences of Negative Interest Rate Policy (NIRP):
Growth, inflation
Bank profitability, micro-structural effects
Financial Stability
Here, focus on exchange rate behavior
Volatility, Uncovered Interest Parity Deviations (UIP)
Literature: little work, no strong results

Negative Nominal Interest Rates and Exchange Rates 2

 Summary of Findings
NIRP: almost no observable consequences for exchange rate behavior

Negative Nominal Interest Rates and Exchange Rates 3

 Data Set
Time span short, hence maximize scope of necessarily limited data set
Include 61 currencies/economies countries
Begin January 2010 (post GFC), continue through May 2016
Daily (highest frequency with many countries)
Switzerland usually base
First negative nominal rates; longest span of time; most negative rates
Sensitivity with US$, GBP, Euro as alternatives

Negative Nominal Interest Rates and Exchange Rates 4

 Data Set, continued
Bilateral rates at 4pm London
Mid-point, ignoring bid/ask
Spot, 1 month (=21 business day) forwards
Effective exchange rates from Bank of England
LIBOR fixings for interest rates
5 economies only (EMU, Japan, Switzerland, UK, USA)
Otherwise 1-m Euro-currency interbank deposit rates (additional 8 countries)
Otherwise Datastream 30-day deposit rates
Sensitivity check: interest rates implicit in forward premium
Sensitivity check: official interest rates

Negative Nominal Interest Rates and Exchange Rates 5

 Country List
Argentina Australia1 Bahrain3
Brazil Botswana4 Bulgaria3
Canada1 Chile China2,4
Colombia Croatia4 Czech. Rep.1,4
Denmark1,3 Egypt4 EMU1
Estonia1,3 Ghana Hong Kong1,2,3
Hungary Iceland1 India2
Indonesia2 Israel1 Japan1,2
Jordan3 Kazakhstan2,4 Kenya
Korea1,2 Kuwait3 Latvia1,3
Lithuania1,3 Malaysia2 Mexico
Morocco3 Norway1 New Zealand1
Oman3 Pakistan2 Peru
Philippines2 Poland Qatar3
Romania Russia Saudi Arabia3
Serbia Singapore1,2 South Africa
Sri Lanka2 Sweden1 Switzerland
Taiwan1,2 Thailand2 Tunisia4
Turkey2 Uganda UK1
United Arab Rep.3 USA1 Vietnam2,4
Zambia
Negative Nominal Interest Rates and Exchange Rates 6
 First Look
Swiss interest rates go negative briefly in August 2011
Follows sudden Swiss Franc appreciation
SNB diagnoses massive overvaluation, loosens to protect competitiveness,
reduce deflationary pressure
September 2011: SNB places floor on Euro/Swiss Franc exchange rate
January 2015: exchange rate constraint removed, jump appreciation, NIRP begins in
earnest

Negative Nominal Interest Rates and Exchange Rates 7

Swiss Interest and Effective Exchange Rates
Swiss Interest and Effective Exchange Rates

180
.5
Interest Exchange

160
0

Exchange Rate
Interest Rate

140
-.5

120
-1

01 Jan 10 01 Jan 12 01 Jan 14 01 Jan 16

LIBOR 1-month interest rate; EER index from Bank of England; 1990=100

Negative Nominal Interest Rates and Exchange Rates 8

 Bilateral (Swiss) Exchange Rates
and National Interest Rates
Swiss Exchange and National Interest Rates
United States EMU

1.4

1.5
.5

1
.4

1
Euro interest
Interest

1.2

Euro/CHF
US$/CHF

.9
Interest Exchange
Exchange
.3

.5

.8
1
.2

.7
-.5
.1

.8
8/2011 1/2015 8/2011 1/2015

01 Jan 10 01 Jan 12 01 Jan 14 01 Jan 16 01 Jan 10 01 Jan 12 01 Jan 14 01 Jan 16

Japan United Kingdom

140

.6 .65 .7 .75 .8 .85

.8
.15

Exchange
British interest
.1

Interest

120

GBP/CHF
.7
Yen/CHF
Exchange
.05

100

.6
0

Interest
-.05

80

.5
-.1

8/2011 1/2015
8/2011 1/2015

01 Jan 10 01 Jan 12 01 Jan 14 01 Jan 16 01 Jan 10 01 Jan 12 01 Jan 14 01 Jan 16

Negative Nominal Interest Rates and Exchange Rates 9

 Little Linkage Between EER Volatility
and Interest Rate Level
Measure volatility as standard deviation (over month) of first-
differences of natural logarithms
No relationship between exchange rate volatility and interest rate
level
Even for negative nominal interest rates!

Negative Nominal Interest Rates and Exchange Rates 10

 Effective Exchange Rate Volatility
and Interest Rates: Switzerland
Switzerland
Monthly observations

4
1/2015
Slope=-.18 (.15)
Exchange rate volatility

9/2011
2

8/2011
1
0

-1 -.5 0 .5
Interest rate
Standard deviation of change in daily log effective exchange rate (%); 30-day annualized interest rate

Negative Nominal Interest Rates and Exchange Rates 11

 Also True of Other Currencies
US $, Euro, Yen, Pound Sterling, Danish Krone, Swedish Krone
4 more currencies with NIRP
Still no strong linkage between exchange rate volatility and interest rate level
Some signs of positive linkage
Nothing unusual when nominal interest rate becomes negative!

Negative Nominal Interest Rates and Exchange Rates 12

 Effective Exchange Rate Volatility
and Interest Rates: Others
Exchange Rate Volatility and Interest Rates
Monthly observations
United States EMU Denmark
1.2

1.2

1.2
Slope=.62 (.18) Slope=.08 (.03) Slope=-.01 (.01)
.8

.8

.8
.4

.4

.4
0

0
-.5 0 .5 1 1.5 2 2.5 -.5 0 .5 1 1.5 2 2.5 -.5 0 .5 1 1.5 2 2.5

Japan 1.2 United Kingdom Sweden

1.2
1.2

Slope=.02 (.17) Slope=.03 (.01)

Slope=.80 (.51)
.8

.8
.8

.4

.4
.4
0

0
-.5 0 .5 1 1.5 2 2.5 -.5 0 .5 1 1.5 2 2.5 -.5 0 .5 1 1.5 2 2.5
Interest rate Interest rate Interest rate

Standard deviation of change in daily log effective exchange rate (%); 30-day annualized interest rate

Negative Nominal Interest Rates and Exchange Rates 13

 Econometric Verification
Regress effective exchange rate volatility against interest rate level
and dummy for NIRP
11 economies with effective rates (Australia, Canada, Denmark, Euro, Japan,
New Zealand, Norway, Sweden, Switzerland, UK, and USA)
5 have NIRP (Denmark, Euro, Japan, Sweden, Switzerland)
Include country-specific FE

(effi,) = + interest, + NegDummyi, + i,

NegDummyi, is 1 if i has negative nominal interest rate at time , 0 ow

Negative Nominal Interest Rates and Exchange Rates 14

 Regressions of Effective Exchange Rate
Volatility on Interest Rates
Interest Rate Dummy, Obs.
Level Negative
Interest Rate
Default .90 1.22 869
(1.52) (2.78)

Negative Nominal Interest Rates and Exchange Rates 15

 Sensitivity Analysis
Interest Rate Dummy, Negative Observations
Level Interest Rate

Add Time -2.48 -4.81 869

FE (1.50) (2.52)
Without Country 4.54** -12.9** 869
FE (.58) (3.1)
Official (not market) 2.70 7.35* 869
interest rates (1.62) (3.01)
2011 .38 n/a 132
(10.9)
2012 9.62** 7.04 143
(3.19) (4.37)
2013 -15.7 3.12 132
(16.7) (7.42)
2014 -.70 -2.91 143
(5.52) (5.66)
2015 -11.84 -9.17 132
(15.53) (23.29)
Without -.88 .39 790
Fixers (1.63) (3.34)
Only lowest half -10.75 -2.54 435
by interest rate (7.16) (4.40)
Without > |2| .56 1.53 844
Outliers (1.08) (1.92)
Negative Nominal Interest Rates and Exchange Rates 16
 True in Bilateral Rates too
Russia only exception to insignificant slope
But minimal Russia interest rate >3% (average >7%)
No sign that negative nominal rates matter

Negative Nominal Interest Rates and Exchange Rates 17

 Bilateral Exchange Rate Volatility
and Interest Rates
Bilateral Exchange Rate Volatility and Interest Rates
Monthly observations
Australia China India
1/2015
0 1 2 3

0 1 2 3
0 1 2 3
1/2015 1/2015
Volatility

2 3 4 5 6 2 4 6 8 4 6 8 10

Indonesia Korea Pakistan

0 1 2 3

0 1 2 3

0 1 2 3
1/2015 1/2015 1/2015
Volatility

4 5 6 7 8 1.5 2 2.5 3 3.5 6 8 10 12 14

Russia Taiwan Turkey

0 2 4 6

0 1 2 3

01234
12/2014 1/2015
Volatility

1/2015
1/2015

5 10 15 20 .4 .5 .6 .7 .8 4 6 8 10 12
National interest rate National interest rate National interest rate

Standard deviation of change in daily log bilateral Swiss exchange rate (%); 30-day annualized interest rate

Negative Nominal Interest Rates and Exchange Rates 18

 Pooling Bilateral Rates
Same conclusion
Interpretation more difficult because of high dependency across
countries in bilateral exchange rates
But can zoom onto small interest rates (-.6, .6%)
Ditto very small interest rates (-.2, .2%)

Negative Nominal Interest Rates and Exchange Rates 19

 Bilateral Exchange Rate Volatility
and Interest Rates: Pooling
Bilateral Exchange Rate Volatility and Interest Rates
Monthly observations, combined across countries/time

Exchange rate volatility

8

8
6

6
4

4
2

2
0

0
-1 -.5 0 .5 0 10 20 30
Swiss interest rate National interest rate
Exchange rate volatility
4

4
DNK
All Outliers 1/2015 BGR
CZE
SWE
EUR
3

3
JPN
2

2
1

1
0

0
-.6 -.3 0 .3 .6 -.2 -.1 0 .1 .2
National interest rate < .6% -.2% < National interest rate < .2%

Standard deviation of change in daily log bilateral Swiss exchange rate (%); 30-day annualized interest rate

Negative Nominal Interest Rates and Exchange Rates 20

 Quick Summary
Little evidence that negative nominal interest rates have affected
exchange rate volatility
But NIRP sometimes prompted by concerns about level of exchange
rate (Denmark, Switzerland)
Now move from second- to first-moment of exchange rate

Negative Nominal Interest Rates and Exchange Rates 21

 Uncovered Interest Parity
Well-known: UIP fails badly in literature
Often ex post changes in exchange rates negatively correlated with forward
premium!
Does the UIP relationship change in the presence of negative nominal
interest rates?
Essentially compare ex post one-month change in bilateral Swiss exchange
rate to forward premium

Negative Nominal Interest Rates and Exchange Rates 22

 What Does the Data Say?
Pooling entails much dependency across
Time (prediction horizon > data frequency) handle with monthly data
Countries (cross-sectional dependency) handle with care!

Little sign of any strong positive relationship

But slope is positive, both for a) whole sample; b) observations with one
negative interest rate (half of sample)

Negative Nominal Interest Rates and Exchange Rates 23

 Monthly Exchange Rate Changes
and Forward Premia
One-Month Exchange Rate Change and Forward Premia
Monthly Observations
Whole Sample (4492 obs) One Negative Interest Rate (2084 obs)
15 30

15 30
0

0
-30 -15

-30 -15
Slope=.39 (.18) Slope=.56 (.19)

0 2 4 6 8 10 0 2 4 6 8 10

Positive Interest Rates (2354 obs) Two Negative Interest Rates (15 obs)
15 30

0 1 2
0

-2 -1
-30 -15

Slope=31 (18)
Slope=-.10 (.23)

0 2 4 6 8 10 .02 .04 .06 .08 .1

Forward Premium Forward Premium

60 currencies/Swiss Franc, 1/2010-5/2016, without Argentina 11/2015

Negative Nominal Interest Rates and Exchange Rates 24

Positive Results Warrant Further Investigation
Zoom into periods of different Swiss interest rates
Histogram suggests: a) periods of very negative rates; and b) periods 0

Swiss interest rates very negative(<-.5%): no relationship

Swiss interest rates tiny positive (<.1%): no relationship
Swiss interest rates tiny negative (>-.1%): positive relationship
Statistically significant but poor fit, few observations
Statistically different slope as interest rates positive/negative

Negative Nominal Interest Rates and Exchange Rates 25

 Monthly Exchange Rate Changes
and Forward Premia: Zooming In
Exchange Rates during Small/Negative Interest Rates
One-Month Exchange Rate Changes and Forward Premia
Histogram Tiny Positive Interest
10 15 20 25

Exchange rate change

Swiss interest (0,.1%)

-.2-.1 .1 .2 .3
Density

0
0 5

Slope=.08 (.22)

-1 -.75 -.5 -.25 0 .25 0 .02 .04 .06 .08 .1

Swiss Interest Rate Forward premium

Negative Interest Rate Tiny Negative Interest

Exchange rate change

Swiss interest <-.5% Swiss interest (-.1%,0)

.3

-.2-.1 .1 .2 .3
-.15 .15
0

0
Slope=.93 (.20)
-.3

Slope=.43 (.25)

0 .02 .04 .06 .08 0 .02 .04 .06 .08 .1

Forward premium Forward premium

Monthly observations for 60 currencies/Swiss Franc, 1/2010-5/2016, without Argentina 11/2015

Negative Nominal Interest Rates and Exchange Rates 26

 Even More Investigation
Switch to Euro; many more observations with interest rates close to
zero (both positive and negative)

Euro interest rates miniscule positive (<.05%): negative relationship

Euro interest rates miniscule negative (>-.05%): no relationship
Quite different from Swiss Franc (none/significantly positive)
Statistical analogue to come

Negative Nominal Interest Rates and Exchange Rates 27

 Monthly Exchange Rate Changes
and Forward Premia: Zooming Into the Euro
Exchange Rates with Similar/Dissimilar Interest Rates
One-Month Exchange Rate Change and Forward Premia
Positive Miniscule Positive
Euro interest >=1.25%, 236 Obs Euro interest [0,.05%], 231 Obs

Exchange Rate Change

.3

.1 .2
Slope=.17 (.87) Slope=-.13 (.01)
0

0
-.2 -.1
-.3

-.025 0 .025 .05 .075 .1 0 .03 .06 .09

Negative Miniscule Negative

Exchange Rate Change

Euro interest <=-.25%, 114 Obs Euro interest [-.05%,0), 171 Obs
.3

.1 .2
Slope=-.69 (1.16) Slope=.35 (.19)
0

0
-.2 -.1
-.3

-.025 0 .025 .05 .075 .1 0 .03 .06 .09

Forward premium Forward premium

Monthly observations for 60 currencies/Euro, without Argentina 11/2015

Negative Nominal Interest Rates and Exchange Rates 28

 Testing UIP
Estimate:

log(si,t+21)-log(si,t) = + [log(fi,t+21,t)-log(si,t)] + Onei,t + Bothi,t + i,t+21,t

Notes:
No risk premium, rational expectations, large sample: =0, =1,
==0
Much of literature has <1 (often negative)
MA errors, so use Newey-West standard errors
Negative Nominal Interest Rates and Exchange Rates 29
 Fama Regressions: NIRP as intercept
Slope Intercept One Negative Two Negative Observations
Interest Rate Interest Rates

Prevalence 50% 49% 1% 93,937

Common .59** .16** 93,937
Intercept (.12) (.06)

Default .58** .13* .07 -.57** 93,937

(.13) (.07) (.08) (.16)

Country .61** n/a .10 -.87** 93,937

FE (.16) (.08) (.20)

Negative Nominal Interest Rates and Exchange Rates 30

 Results
UIP works poorly: easily reject =0, =1
Doesnt change with NIRP dummies
Results robust to robustness checks
But UIP works better than usual (>0)
Can also check if slopes vary by NIRP (multiplicative, not additive)

Negative Nominal Interest Rates and Exchange Rates 31

 Fama Regressions: NIRP as slope
No Negative One Negative Two Negative Observations
Interest Rates Interest Rate Interest Rates

Default -.06 .74** -14** 93,937

(.11) (.14) (3)
Country -.14 .78** -17** 93,937
FE (.16) (.13) (4)

US$ .20* .51** n/a 88,979

Base (.08) (.11)

Euro -.02 .76** -2.11 93,937

Base (.11) (.13) (1.80)

Negative Nominal Interest Rates and Exchange Rates 32

 Promising Results Warrant Investigation
Use regression discontinuity approach to focus on importance of
negative rates
Use Euro rates (many observations with interest rates 0) on:

log(si,t+21)-log(si,t) = [(P + P)*POSi,t][log(fi,t+21,t)-log(si,t)]

+ [(N + N)*NEGi,t][log(fi,t+21,t)-log(si,t)] + i,t+21,t

Where POS/NEG is dummy for country i with positive/negative interest rates

Negative Nominal Interest Rates and Exchange Rates 33

 Testing for Slope Discontinuity
of Fama Regression
Size of Euro Euro Interest Rate Equality Test Observations
Interest rate (p-value)
Positive Negative
In +/- .05% .25 (.32) -.19 (.20) 1.5 (.22) 9,526
In +/- .10% .76 (.45) -.23 (.16) 1.3 (.25) 37,742
In +/- .15% .42 (.27) .27 (.16) .3 (.62) 42,919
In +/- .20% .77 (.11) .37 (.17) 4.2* (.04) 47,188
In +/- .25% .75 (.11) .47 (.17) 2.0 (.16) 54,689
Negative Nominal Interest Rates and Exchange Rates 34
 Another Approach: Carry Trade Returns
Carry trade relies on UIP deviations
Consensus in literature of positive but risky returns (Burnside et al)
We ask Do carry trade returns vary with negative nominal interest
rates?

Negative Nominal Interest Rates and Exchange Rates 35

 Constructing Carry Trade Returns
1. Begin with Swiss Franc as default currency to measure cumulative
returns.
Also use Pound Sterling and American dollar for sensitivity
2. Each month, sort all 60 currencies (excluding base) by interest rate
Use interest rates implied by CIP through forward premium
Also use explicit interest rates
3. Form two portfolios
Short portfolio with lowest three interest rates (equally weighted)
Long portfolio with highest three interest rates
Also consider portfolios with five and ten currencies
4. Construct returns for (long, short and) long minus short portfolios
5. Each month, repeat steps 2-4

Negative Nominal Interest Rates and Exchange Rates 36

 Carry Trade Returns
Flow and Cumulative Excess Returns
Returns from long-short strategies in 3 base currencies (# currencies/portfolio)

Cumulative returns
Swiss Franc, (3) Swiss Franc, (5) Swiss Franc, (10)
Flow returns

0 75 150

0 75 150

0 75 150
10
10
10

0
0

0
-10

-10

-10
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

Cumulative returns
Pound Sterling, (3) Pound Sterling, (5) Pound Sterling, (10)
Flow returns

0 75 150

0 75 150

0 75 150
10

10
10

0
0
-10

-10

-10
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

Cumulative returns
American Dollar, (3) American Dollar, (5) American Dollar, (10)
Flow returns

0 75 150

0 75 150

0 75 150
10

10
10

0
0
-10

-10

-10
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

Flow/cumulative returns: thin/thick, solid/dashed line, left/right axis. Implicit interest rates.

Negative Nominal Interest Rates and Exchange Rates 37

 Using Explicit Interest Rates
Flow and Cumulative Excess Returns
Returns from long-short strategies in 3 base currencies (# currencies/portfolio)

Cumulative returns
Swiss Franc, (3) Swiss Franc, (5) Swiss Franc, (10)

0 25 50

0 25 50

0 25 50
5

5
-5

-5

-5
-15

-15

-15
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

Cumulative returns
Pound Sterling, (3) Pound Sterling, (5) Pound Sterling, (10)

0 25 50

0 25 50

0 25 50
5

5
-5

-5

-5
-15

-15

-15
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

Cumulative returns
American Dollar, (3) American Dollar, (5) American Dollar, (10)
0 25 50

0 25 50

0 25 50
5

5
5
-5

-5

-5
-15

-15

-15
Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16 Jan 10 Jan 12 Jan 14 Jan 16

% Flow/cumulative returns: thin/thick, solid/dashed line, left/right axis. LIBOR/Euro/National interest rates.

Negative Nominal Interest Rates and Exchange Rates 38

 Carry Trade Returns
Pervasive but risky
Higher with fewer currencies in portfolios
But do returns vary with NIRP?
Estimate:
CARRYc,s,i,t = + NEGt + c,s,i,t

CARRYc,s,i,t monthly flow carry-trade return measured in currency c, with s

currencies in both long/short portfolios, using measure i of interest rates
(implicit in forward rates/explicit) at month t,
NEGt importance of negative interest rates at t (Any? number?)

Negative Nominal Interest Rates and Exchange Rates 39

 Returns from Long-Short Portfolios
and Negative Interest Rates
Currency Portfolio Interest Number of Negative Any Negative
Size Rates Interest Rate Interest Rates
Swiss Franc 3 Implicit .002 .006
(.002) (.007)
Swiss Franc 5 Implicit .001 .007
(.001) (.006)
Swiss Franc 10 Implicit .000 .002
(.001) (.004)
Pound Sterling 3 Implicit .002 .007
(.002) (.007)
American Dollar 3 Implicit .002 .006
(.002) (.007)
Swiss Franc 3 National -.003 -.005
(.002) (.007)
Negative Nominal Interest Rates and Exchange Rates 40
 Negative Results
No evidence that carry trade returns depend on negative nominal
interest rates

Negative Nominal Interest Rates and Exchange Rates 41

 Conclusion
No evidence of strong effects of NIRP on exchange rate behavior
Volatility unaffected by level of interest rates, especially around 0
UIP works better recently, but no differences around 0 interest rates
Carry trade returns unaffected
Caveat: have ignored most consequences of NIRP
Growth, inflation
Bank profitability, micro-structural effects
Financial Stability
Another caveat: limited sample
Only 5 economies for limited period of time

Negative Nominal Interest Rates and Exchange Rates 42