Exchange Rates, Monetary Policy Statements, and Uncovered Interest Parity: Before and after the Zero Lower Bound
28 Pages Posted: 9 Apr 2013
Date Written: January 18, 2013
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: Suggested Citation