The relationship between interest rates and exchange rates is puzzling and poorly understood. But under some standard assumptions, interest rates can be adjusted to smooth real exchange rate movements at the possible price of increased volatility in other variables. Estimates made under some generous suppositions about what monetary policy is able to accomplish suggest that decreasing real exchange rate volatility by about 25 per cent would require increasing output volatility by about 10-15 per cent, inflation volatility by about 0-15 per cent and interest rate volatility by about 15-40 per cent.
West, Kenneth (2003). ‘Monetary policy and the volatility of real exchange rates in New Zealand’, New Zealand Economic Papers, Taylor and Francis Journals, Volume 37(2), Pages 175-196, DOI: https://doi.org/10.1080/00779950309544383.