The Dornbusch sticky price model: A research on impact of interest rate on exchange rate in Vietnam

Abstract

    This paper researches the impact of interest rate on exchange rate in Vietnam following the Dornbusch sticky price monetarist model. Based on the theoretical basis, authors applied a structural vector autogressive model with macroeconomic variables from 1998 to 2012. The results show that: (i) the response of exchange rate to the change of interest rate in Vietnam follows the Dornbusch model; (ii) apart from interest rate, exchang rate is affected by other factors such as money supply, inflation, and exchange rate fluctuation itself. The authors suggest some recommendations: (i) The State bank of Vietnam can use interest rate policy to manage exchange rate in some periods with several conditions; (ii) the strong influence of monetary factors and psychology on exchange rate implies that long run exchange rate stability requires a consistent management of monetary policy with stable price as a prior target.