Testing for Uip: Nonlinearities, Monetary Announcements and Interest Rate Expectations

28 Pages Posted: 23 Apr 2021

See all articles by Christina Anderl

Christina Anderl

London South Bank University

Guglielmo Maria Caporale

Brunel University London - Department of Economics and Finance; London South Bank University; CESifo (Center for Economic Studies and Ifo Institute); German Institute for Economic Research (DIW Berlin)

Date Written: 2021

Abstract

This paper re-examines the UIP relation by estimating first a benchmark linear Cointegrated VAR including the nominal exchange rate and the interest rate differential as well as central bank announcements, and then a Cointegrated Smooth Transition VAR (CVSTAR) model incorporating nonlinearities and also taking into account the role of interest rate expectations. The analysis is conducted for five inflation targeting countries (the UK, Canada, Australia, New Zealand and Sweden) and three non-targeters (the US, the Euro-Area and Switzerland) using daily data from January 2000 to December 2020. We find that the nonlinear framework is more appropriate to capture the adjustment towards the UIP equilibrium, since the estimated speed of adjustment is substantially faster and the short-run dynamic linkages are stronger. Further, interest rate expectations play an important role: a fast adjustment only occurs when the market expects the interest rate to increase in the near future, namely central banks are perceived as more credible when sticking to their goal of keeping inflation at a low and stable rate. Also, central bank announcements have a more sizeable short-run effect in the nonlinear model. Finally, UIP holds better in inflation targeting countries, where monetary authorities appear to achieve a higher degree of credibility.

JEL Classification: C320, F310, G150

Suggested Citation

Anderl, Christina and Caporale, Guglielmo Maria, Testing for Uip: Nonlinearities, Monetary Announcements and Interest Rate Expectations (2021). Available at SSRN: https://ssrn.com/abstract=3832482 or http://dx.doi.org/10.2139/ssrn.3832482

Christina Anderl

London South Bank University ( email )

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Guglielmo Maria Caporale (Contact Author)

Brunel University London - Department of Economics and Finance ( email )

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London South Bank University ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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German Institute for Economic Research (DIW Berlin) ( email )

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