<blockquote>
  <p>According to the interest rate parity condition , if there is a depreciation of the domestic exchange rate, then the domestic interest rate will increase and the foreign interest rate will decrease. Am i Correct?</p>
</blockquote>

<p>This verbal formulation does not match what interest rate parity states. Note that there are two versions of interest rate parity: covered interest rate parity (an arbitrage condition), and uncovered interest rate parity (an equilibrium condition that appears questionable).</p>

<p>See this question for a description of interest rate parity: <a href="https://economics.stackexchange.com/questions/4914/interest-rate-parity-counter-intuitive">link to question</a> I will not repeat the description of interest rate parity, as it is done in that answer.</p>

<p>In both versions of interest rate parity, what matters is <em>expected</em> depreciation, not a historical event of depreciation.</p>

<p>The statement that interest rates adjust in reaction to expected exchange rate movements is also questionable. Short-term rates are largely under control of central banks in floating currencies, and so a more plausible description is that expected currency movements conform to interest rate differentials.</p>

CC BY-SA 4.0
2020-04-07T14:06:11.840Z
2020-04-07T14:06:11.840Z
Brian Romanchuk
<p>According to the interest rate parity condition , if there is a depreciation of the domestic exchange rate, then the domestic interest rate will increase and the foreign interest rate will decrease. Am i Correct? </p>

<macroeconomics>
Effect of a depreciation on foreign interest rate?
Sara Saletti
# Effect of a depreciation on foreign interest rate?

(Asked by: username_0 on 2020-04-07)

According to the interest rate parity condition , if there is a depreciation of the domestic exchange rate, then the domestic interest rate will increase and the foreign interest rate will decrease. Am i Correct?

**Tags:** macroeconomics


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## 1 answers

### Answer by username_1 on 2020-04-07. Score: 0 | Accepted answer

> According to the interest rate parity condition , if there is a depreciation of the domestic exchange rate, then the domestic interest rate will increase and the foreign interest rate will decrease. Am i Correct?

This verbal formulation does not match what interest rate parity states. Note that there are two versions of interest rate parity: covered interest rate parity (an arbitrage condition), and uncovered interest rate parity (an equilibrium condition that appears questionable).

See this question for a description of interest rate parity: [link to question](https://economics.stackexchange.com/questions/4914/interest-rate-parity-counter-intuitive) I will not repeat the description of interest rate parity, as it is done in that answer.

In both versions of interest rate parity, what matters is *expected* depreciation, not a historical event of depreciation.

The statement that interest rates adjust in reaction to expected exchange rate movements is also questionable. Short-term rates are largely under control of central banks in floating currencies, and so a more plausible description is that expected currency movements conform to interest rate differentials.


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