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Can Monetary Policy Cause the Uncovered Interest Parity Puzzle?

Author

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  • Cheolbeom Park

    () (Department of Economics, Korea University, Seoul, Republic of Korea)

  • Sookyung Park

    () (Department of Economics, Korea University, Seoul, Republic of Korea)

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 all 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. Iceland has put greater weight on inflation in the policy rule after the crisis, and the UIP puzzle has become more severe there after the crisis, which is also consistent with our model. Moreover, 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.

Suggested Citation

  • Cheolbeom Park & Sookyung Park, 2014. "Can Monetary Policy Cause the Uncovered Interest Parity Puzzle?," Discussion Paper Series 1404, Institute of Economic Research, Korea University.
  • Handle: RePEc:iek:wpaper:1404
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    Cited by:

    1. 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.
    2. 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.
    3. Yuhyeon Bak & Cheolbeom Park, 2020. "Exchange Rate Predictability, Risk Premiums, and Predictive System," Discussion Paper Series 2006, Institute of Economic Research, Korea University.
    4. 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;
    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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