Working Paper Series, Department of Economics, Uppsala University
No 2002:17:
Can Endogenous Monetary Policy Explain the Deviations from UIP
Annika Alexius
Abstract: The co-movements of nominal exchange rates and short-term
interest rates as the economy is hit by shocks is a potential source of ex
post deviations from uncovered interest rate parity. This paper
investigates whether an established model of endogenous monetary policy in
an open economy is capable of explaning the exchange rate risk premium
puzzle. Time series on interest differentials and exchange rate changes are
generated from the Svensson (2000) model. Uncovered interest rate parity is
tested on the simulated data and the b-coefficients are investigated. For
most realistic choices of parameter values, the b-coefficients are positive
but much smaller than the unity value expected from UIP. It is however also
possible to obtain large, negative b-coefficients if the central bank is
engaged in interest rate smoothing.
Keywords: Monetary policy; Uncovered interest parity; Exchange rate risk premium; (follow links to similar papers)
JEL-Codes: E52; F31; F41; (follow links to similar papers)
34 pages, August 15, 2002
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