Analysis of the relationship between interest rate and exchange rate within boarders of a small open economy

Primary objective of this thesis was to analyse the relationship between exchange rate and interest rate within borders of a small open economy. Different theoretical approaches often present us with various, sometimes even opposing conclusions when it comes to the matter of direction and intensity of the causal influence between these two variables. From author's point of view it is important to perceive the interaction between exchange rate and interest rate as a dynamic process rather than a static relationship. The empirical analysis was conducted on monthly time series (2000-2012) of three selected small open economies -- Poland, Hungary and Czech Republic. Graphical analysis, linear regression, vector autoregression and cointegration analysis were selected as suitable tools for meeting the objective of this thesis. Models themselves presented us with interesting conclusions, for example a proof of the international Fisher effect, exchange rate causally affecting the interest rate (interest rate differential) in case of spot rates against euro. Another curious phenomena was the inflow of foreign debt capital, which, as it seems, was actually pulling the exchange rate down rather than pushing it up due to rising indebtedness of the economy