Uncovered Interest Parity and Monetary Policy Near and Far from the Zero Lower Bound

Menzie Chinn and Yi Zhang ()
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Yi Zhang: University of California at Davis

Open Economies Review, 2018, vol. 29, issue 1, No 1, 30 pages

Abstract: Abstract Relying upon a standard New Keynesian DSGE, we propose an explanation for two empirical findings in the international finance literature. First, the unbiasedness hypothesis — the proposition that expost exchange rate depreciation matches interest differentials — is rejected much more strongly at short horizons than at long. Second, even at long horizons, the unbiasedness hypothesis tends to be rejected when one of the currencies has experienced a long period of low interest rates, such as in Japan and Switzerland. Using a calibrated New Keynesian dynamic stochastic general equilibrium model, we show how a monetary policy rule can induce the negative (positive) correlation between depreciation and interest differentials at short (long) horizons. The tendency to reject unbiasedness for Japan and Switzerland even at long horizons we attribute to the interaction of the monetary reaction function and the zero lower bound.

Keywords: Uncovered interest parity; Unbiasedness hypothesis; Rational expectations; Exchange rates; Zero lower bound; New Keynesian model (search for similar items in EconPapers)
JEL-codes: E12 F21 F31 F41 F47 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (7)

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Working Paper: Uncovered Interest Parity and Monetary Policy Near and Far from the Zero Lower Bound (2015)
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DOI: 10.1007/s11079-017-9474-8

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