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Monetary Policy and the Uncovered Interest Rate Parity Puzzle: Theory and Empirical Results for Oceania
Author(s) -
Guender Alfred V.
Publication year - 2014
Publication title -
economic record
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.365
H-Index - 42
eISSN - 1475-4932
pISSN - 0013-0249
DOI - 10.1111/1475-4932.12097
Subject(s) - economics , interest rate parity , international fisher effect , exchange rate , fisher hypothesis , interest rate , monetary economics , inflation (cosmology) , nominal interest rate , monetary policy , real interest rate , open economy , macroeconomics , econometrics , physics , theoretical physics
This article offers a theory‐based explanation for why high‐ interest‐rate countries see their currencies appreciate, the so‐called UIP puzzle. The central bank bases its target rule on the lag of the policy instrument and the CPI inflation rate. When combined with a stylised model of an open economy, the endogenous target rule can account for the systematic negative relation between the change in the exchange rate and the lagged interest rate differential. Foreign inflation and the foreign interest rate also affect nominal exchange rate changes. The model‐based behaviour of the exchange rate is tested on New Zealand and Australian data with mixed results.