Can monetary policy cause the uncovered interest parity puzzle?

Cheolbeom Park, Sookyung Park

Research output: Contribution to journalArticle

3 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)34-44
Number of pages11
JournalJapan and the World Economy
Volume41
DOIs
Publication statusPublished - 2017 Mar 1

Keywords

  • Exchange rate
  • Interest rate
  • Monetary policy rule
  • Uncovered interest parity

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics
  • Political Science and International Relations

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