 A reconsideration of the failure of uncovered interest parity for the U.S. dollarCharles Engel, Katya Kazakova, Mengqi Wang and Nan Xiang Journal of International Economics, 2022, vol. 136, issue C Abstract: We reexamine the time-series evidence on uncovered interest rate parity for the U.S. dollar versus major currencies at short-, medium- and long-horizons. The evidence that interest rate differentials predict foreign exchange returns is not stable over time and disappears altogether when interest rates are near the zero-lower bound. However, we find that year-on-year inflation rate differentials predict excess returns – when the U.S. y.o.y. inflation rate is relatively high, subsequent returns on U.S. deposits tend to be high. We interpret this as consistent with the hypothesis that markets underreact initially to predictable changes in future monetary policy. The predictive power of y.o.y. inflation begins in the mid-1980s when central banks began to target inflation consistently and continues in the post-ZLB period when interest rates lose their primacy as a policy instrument. We attempt to address some econometric problems that might bias the conventional Fama (1984) test. Keywords: Uncovered interest parity; Forward premium puzzle; Fama puzzle (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:136:y:2022:i:c:s0022199622000344 DOI: 10.1016/j.jinteco.2022.103602 Access Statistics for this article Journal of International Economics is currently edited by Gourinchas, Pierre-Olivier and RodrÃguez-Clare, Andrés More articles in Journal of International Economics from Elsevier |
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