Uncovered Interest Parity, Forward Guidance and the Exchange Rate

  • Authors: Jordi Galí.
  • BSE Working Paper: 1021 | February 18
  • Keywords: unconventional monetary policies , forward guidance puzzle , uncovered interest rate parity , open economy New Keynesian model
  • JEL codes: E43, E58, F41
  • unconventional monetary policies
  • forward guidance puzzle
  • uncovered interest rate parity
  • open economy New Keynesian model
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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.

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