Uncovered Interest Parity, Forward Guidance, and the Exchange Rate

37 Pages Posted: 2 Mar 2020

See all articles by Jordi Galí

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

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Date Written: February 2020

Abstract

Under uncovered interest parity (UIP), the size of the effect on the real exchange rate of an anticipated change in real interest rate differentials is invariant to the horizon at which the change is expected. Empirical evidence using US, euro area and UK data points to a substantial deviation from that invariance prediction: expectations of interest rate differentials in the near (distant) future are shown to have much larger (smaller) effects on the real exchange rate than is implied by UIP. Some possible explanations are discussed.

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Suggested Citation

Gali, Jordi, Uncovered Interest Parity, Forward Guidance, and the Exchange Rate (February 2020). NBER Working Paper No. w26797, Available at SSRN: https://ssrn.com/abstract=3547146

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