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Systematic monetary policy and the forward premium puzzle

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  • Demosthenes N. Tambakis
  • Nikola Tarashev

Abstract

Is systematic monetary policy a driver of the forward premium puzzle, i.e. the tendency of high interest-rate currencies to appreciate, thus strongly violating Uncovered Interest Parity (UIP)? We address this question by studying a battery of monetary policy rules in a small open economy that is subject to stationary but persistent domestic and foreign shocks. Each rule leads to model-implied UIP violations, which we derive analytically and then calibrate numerically. Our key finding is that only a forward-looking rule based on CPI inflation can account for frequently observed strong UIP violations.

Suggested Citation

  • Demosthenes N. Tambakis & Nikola Tarashev, 2012. "Systematic monetary policy and the forward premium puzzle," BIS Working Papers 396, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:396
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    References listed on IDEAS

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    Cited by:

    1. Park, Cheolbeom & Park, Sookyung, 2017. "Can monetary policy cause the uncovered interest parity puzzle?," Japan and the World Economy, Elsevier, vol. 41(C), pages 34-44.

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