Can Monetary Policy Cause the Uncovered Interest Parity Puzzle?

Cheolbeom Park and Sookyung Park ()
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Sookyung Park: Department of Economics, Korea University, Seoul, Republic of Korea

No 1404, Discussion Paper Series from Institute of Economic Research, Korea University

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.

Keywords: Interest rate; Exchange rate; Monetary policy rule; Uncovered interest (search for similar items in EconPapers)
JEL-codes: F31 F41 F47 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cba, nep-mon and nep-opm
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Journal Article: Can monetary policy cause the uncovered interest parity puzzle? (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:iek:wpaper:1404

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