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The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules / Charles Engel, Dohyeon Lee, Chang Liu, Chenxin Liu, Steve Pak Yeung Wu.
- Format:
- Book
- Author/Creator:
- Engel, Charles.
- Series:
- Working Paper Series (National Bureau of Economic Research) no. w24059.
- NBER working paper series no. w24059
- Language:
- English
- Physical Description:
- 1 online resource: illustrations (black and white);
- Place of Publication:
- Cambridge, Mass. National Bureau of Economic Research 2017.
- Summary:
- Recent research has found that the Taylor-rule fundamentals have power to forecast changes in U.S. dollar exchange rates out of sample. Our work casts some doubt on that claim. However, we find strong evidence of a related in-sample anomaly. When we include U.S. inflation in the well-known uncovered interest parity regression of the change in the exchange rate on the interest-rate differential, we find that the inflation variable is highly significant and the interest-rate differential is not. Specifically, high U.S. inflation in one month forecasts dollar appreciation in the subsequent month. We introduce a model in which a Taylor rule determines monetary policy, but in which not only monetary shocks but also liquidity shocks drive nominal interest rates. This model can potentially account for the empirical findings.
- Notes:
- Print version record
- November 2017.
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