Exchange Rates and Interest Rates: An Empirical Investigation of International Fisher Effect Theory The Case of Egypt (2003-2012)

This paper examines the validity of the International Fisher Effect (IFE) theory for the Egyptian economy. Two case studies are investigated: Egypt vs. USA and Egypt vs. Germany during the period (2003-2012). The long run relationship between nominal changes in exchange rate and nominal interest rate differential for each of the two case studies is examined using the Autoregressive Distributed Lag bounds test approach to co-integration and error correction model. The short run relationship is examined through impulse response function and variance decomposition. In addition, the Granger causality test is employed to identify the direction of the relationship. The empirical findings revealed partial significance of IFE in the case of Egyptian pound vs. US dollars, while no sign of IFE was detected in the case of Egyptian pound vs. Euro currency. The irrelevance of IFE could be attributed to the irrelevance of Purchasing Power Parity theory in Egypt. This is in addition to Egypt’s limited financial integration with international financial markets.