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Can monetary policy cause the uncovered interest parity puzzle?

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  • Park, Cheolbeom
  • Park, Sookyung

Abstract

Using a typical open macroeconomic model, we show that the UIP puzzle becomes more pronounced when the monetary policy rule is stricter against inflation. To determine the empirical validity of our model, we examine (the Taylor-rule-type) monetary policy rules and the slope coefficient in the regression of future exchange rate returns on interest rate differentials before and after the recent global financial crisis. We find that economies that reduced the reaction of the policy interest rate to inflation in response to the crisis have positive slope coefficients in the UIP regressions after the crisis, which is consistent with our model. However, economies for which we cannot find clear break evidence for the reaction to inflation in the monetary policy rule do not show a clear directional change in the slope coefficient of the UIP regression. Moreover, the relation implied by our model holds robustly with longer time-series data during the periods prior to the crisis.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:japwor:v:41:y:2017:i:c:p:34-44
    DOI: 10.1016/j.japwor.2016.12.001
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    Cited by:

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    2. Yuhyeon Bak & Cheolbeom Park, 2020. "Exchange Rate Predictability, Risk Premiums, and Predictive System," Discussion Paper Series 2006, Institute of Economic Research, Korea University.
    3. Coulibaly, Dramane & Kempf, Hubert, 2019. "Inflation targeting and the forward bias puzzle in emerging countries," Journal of International Money and Finance, Elsevier, vol. 90(C), pages 19-33.
    4. Ogrokhina, Olena & Rodriguez, Cesar M., 2019. "The effect of inflation targeting and financial openness on currency composition of sovereign international debt," Journal of International Money and Finance, Elsevier, vol. 97(C), pages 1-18.
    5. Adewuyi, Adeolu O. & Ogebe, Joseph O., 2019. "The validity of uncovered interest parity: Evidence from african members and non-member of the organisation of petroleum exporting countries (OPEC)," Economic Modelling, Elsevier, vol. 82(C), pages 229-249.

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    More about this item

    Keywords

    Interest rate; Exchange rate; Monetary policy rule; Uncovered interest parity;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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