Nominal Exchange Rate Dynamics and Monetary Policy: Uncovered Interest Rate Parity and Purchasing Power Parity Revisited

33 Pages Posted: 15 Oct 2018 Last revised: 22 Oct 2018

See all articles by Yossi Saadon

Yossi Saadon

Bank of Israel - Research Department

Nathan Sussman

Hebrew University of Jerusalem

Date Written: October 2018

Abstract

The increasing globalization of trade in goods and services and the deepening of financial markets have reduced frictions that may impede the operation of the PPP and UIP relationships in the short run. In this paper, we estimate the short term relative PPP and UIP relationships. Using data from Israel, which has a deep market for inflation expectations for 12 months, we show that relative PPP and UIP cannot be rejected. Deviations from equilibrium last less than a year. Data from Israel's capital account of the balance of payments shows that the deviations are not destabilizing. Our findings suggest that greater globalization and financial deepening contribute to the effectiveness of monetary policy.

Keywords: Balance sheet effects, Exchange Rates, Inflation expectations, monetary policy, purchasing power parity, uncovered interest rate parity

JEL Classification: E52, F3, F31, F41, G15

Suggested Citation

Saadon, Yossi and Sussman, Nathan, Nominal Exchange Rate Dynamics and Monetary Policy: Uncovered Interest Rate Parity and Purchasing Power Parity Revisited (October 2018). CEPR Discussion Paper No. DP13235. Available at SSRN: https://ssrn.com/abstract=3266428

Yossi Saadon (Contact Author)

Bank of Israel - Research Department ( email )

PO Box 780
Jerusalem 91007
Israel

Nathan Sussman

Hebrew University of Jerusalem ( email )

Mount Scopus
Jerusalem 91905, IL Jerusalem 91905
Israel

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