Systematic monetary policy and the forward premium puzzle
Demosthenes Tambakis () and
Nikola Tarashev ()
No 396, BIS Working Papers from Bank for International Settlements
Is systematic monetary policy a driver of the forward premium puzzle, i.e. the tendency of high interest-rate currencies to appreciate, thus strongly violating Uncovered Interest Parity (UIP)? We address this question by studying a battery of monetary policy rules in a small open economy that is subject to stationary but persistent domestic and foreign shocks. Each rule leads to model-implied UIP violations, which we derive analytically and then calibrate numerically. Our key finding is that only a forward-looking rule based on CPI inflation can account for frequently observed strong UIP violations.
Keywords: monetary policy rules; uncovered interest parity; exchange rate dynamics; inflation-targeting (search for similar items in EconPapers)
Pages: 42 pages
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:396
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