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UIP, Expectations and the Kiwi

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Author Info
Anella Munro (Reserve Bank of New Zealand)
Abstract

This paper looks at reduced form descriptions of changes in the USD/NZD exchange rate, with emphasis on the interest rate-exchange rate relationship. In the estimated reduced form equations, high domestic short term interest rates relative to foreign interest rates are associated with continued upward pressure on the New Zealand dollar. This effect is most pronounced for the 6-month forward interest differential, and is reinforced by some "inertia" but moderated by deviations from equilibrium as "over or under-valuation" erodes expected returns. Changes in commodity export prices are estimated to have short term effects. Some aspects of the estimated equations are consistent with forward-looking rational expectations, a standard feature of open economy models. Other aspects of the estimated equations suggest random walk exchange rate expectations consistent with Meese and Rogoff (1983). The cross correlation between interest differentials and the exchange rate may be difficult to reconcile with rational expectations. The forecasting performance of a reduced form equation is also assessed.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2005/05.

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Date of creation: Oct 2005
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Handle: RePEc:nzb:nzbdps:2005/05

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F31 - International Economics - - International Finance - - - Foreign Exchange
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Johansen, S[empty]ren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244. [Downloadable!] (restricted)
  2. Lucio Sarno, 2005. "Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?," Canadian Journal of Economics, Canadian Economics Association, vol. 38(3), pages 673-708, August. [Downloadable!] (restricted)
  3. Paul R. Bergin, 2004. "How Well Can the New Open Economy Macroeconomics Explain the Exchange Rate and Current Account?," NBER Working Papers 10356, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  5. Athanasios Orphanides & John C. Williams, 2003. "Inflation scares and forecast-based monetary policy," Finance and Economics Discussion Series 2003-41, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  6. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  7. Simon Wren-Lewis, 2004. "A model of Equilibrium Exchange Rates for the New Zealand and Australian dollar," Reserve Bank of New Zealand Discussion Paper Series DP 2004/07, Reserve Bank of New Zealand. [Downloadable!]
  8. Dominick Stephens, 2004. "The equilibrium exchange rate according to PPP and UIP," Reserve Bank of New Zealand Discussion Paper Series DP 2004/03, Reserve Bank of New Zealand. [Downloadable!]
  9. Bacchetta, Philippe & van Wincoop, Eric, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," CEPR Discussion Papers 3808, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February. [Downloadable!] (restricted)
  11. Frenkel, Jacob A & Mussa, Michael L, 1980. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence," American Economic Review, American Economic Association, vol. 70(2), pages 374-81, May. [Downloadable!] (restricted)
  12. Yin-Wong Cheung & Menzie D. Chinn & Antonio Garcia Pascual, 2002. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," NBER Working Papers 9393, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Philippe Bacchetta & Eric van Wincoop, 2005. "Can Information Heterogeneity Explain the Exchange Rate Determination?," FAME Research Paper Series rp155, International Center for Financial Asset Management and Engineering. [Downloadable!]
  15. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
  16. Jacob A. Frenkel & Michael L. Mussa, 1980. "Efficiency of Foreign Exchange Markets and Measures of Turbulence," NBER Working Papers 0476, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Harvey, David I & Leybourne, Stephen J & Newbold, Paul, 1998. "Tests for Forecast Encompassing," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(2), pages 254-59, April.
  18. Angela Huang, 2004. "Examining finite-sample problems in the application of cointegration tests for long-run bilateral exchange rates," Reserve Bank of New Zealand Discussion Paper Series DP 2004/08, Reserve Bank of New Zealand. [Downloadable!]
  19. Christian Hawkesby & Christie Smith & Christine Tether, 2000. "New Zealand's currency risk premium," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 63, September. [Downloadable!]
  20. Froot, Kenneth A & Frankel, Jeffrey A, 1989. "Forward Discount Bias: Is It an Exchange Risk Premium?," The Quarterly Journal of Economics, MIT Press, vol. 104(1), pages 139-61, February. [Downloadable!] (restricted)
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  21. Kenneth Rogoff & Yu-chin Chen, 2002. "Commodity Currencies and Empirical Exchange Rate Puzzles," IMF Working Papers 02/27, International Monetary Fund.
  22. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Dominick Stephens, 2006. "Should monetary policy attempt to reduce exchange rate volatility in New Zealand?," Reserve Bank of New Zealand Discussion Paper Series DP2006/05, Reserve Bank of New Zealand. [Downloadable!]
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