Uncovered Interest Parity: A Further Reconsideration
AbstractThis paper reexamines the uncovered interest parity condition within the context of a structural view of real exchange rate determination that emphasizes the real exchange rate as the relative price of domestic in terms of foreign output. This structural interpretation complements rather than replaces the asset-market view of nominal exchange rate determination. Because structural shocks to the real exchange rate are unpredictable, forward discounts need not predict actual future nominal exchange rate movements with any reliability, except in cases where there are continuing long-term differences in countries' inflation rates. Once the integrated nature of the world capital market is taken into account, it turns out that governments can and probably do smooth price levels, nominal exchange rates and possibly also domestic/foreign interest rate differentials, but have no power to manipulate any of these variables independently of the others. As a result, they cannot bring about major movements in real exchange rates without destabilizing the economy.
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Bibliographic InfoPaper provided by University of Toronto, Department of Economics in its series Working Papers with number floyd-95-01.
Length: 30 pages
Date of creation: 13 Mar 1995
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Find related papers by JEL classification:
- F3 - International Economics - - International Finance
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-06-07 (All new papers)
- NEP-IFN-2004-06-07 (International Finance)
- NEP-MON-2004-06-07 (Monetary Economics)
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