Uncovered Interest Parity, Forward Guidance and the Exchange Rate

Abstract

Under uncovered interest parity (UIP), the size of the e¤ect on the real exchange rate of an anticipated change in real interest rate di¤erentials is invariant to the horizon at which the change is expected. Empirical evidence using US, euro area and UK data points to a substantial deviation from that invariance prediction: expectations of interest rate di¤erentials in the near (distant) future are shown to have much larger (smaller) e¤ects on the real exchange rate than is implied by UIP. Some possible explanations are discussed.

Published as: Uncovered Interest Parity, Forward Guidance and the Exchange Rate in Journal of Money, Credit and Banking , Vol. 52, No. S2, 465-496, December, 2020