Exchange Rates, Monetary Policy Statements, and Uncovered Interest Parity: Before and after the Zero Lower Bound

28 Pages Posted: 9 Apr 2013

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Date Written: January 18, 2013

Abstract

While uncovered interest parity (UIP) fails unconditionally, UIP conditional on monetary policy actions remains a cornerstone of macroeconomic models used for monetary policy analysis. We posit that monetary policy actions are partially revealed by FOMC statements and propose a new identification strategy to uncover the degree to which such policy actions induce comovement in exchange rates and long-term interest rates consistent with uncovered interest parity. We reach three conclusions. First, there is evidence in favor of UIP at long horizons, conditional on monetary policy actions, for Dollar/Euro and Dollar/Yen exchange rates. Second, short-run movements in exchange rates following monetary policy surprises are consistent with the overshooting prediction of Dornbusch (1976), although our approach cannot test UIP at short horizons. Finally, we examine the degree to which monetary policy statements since the onset of the zero-lower bound (ZLB) on the short-term interest rate in the United States have engendered different comovement between long-term interest rates and exchange rates and find little evidence for a change in relationships.

Keywords: Monetary policy, exchange rates

JEL Classification: E52, F31, G14

Suggested Citation

Kiley, Michael T., Exchange Rates, Monetary Policy Statements, and Uncovered Interest Parity: Before and after the Zero Lower Bound (January 18, 2013). FEDS Working Paper No. 2013-17. Available at SSRN: https://ssrn.com/abstract=2246910 or http://dx.doi.org/10.2139/ssrn.2246910

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

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