DP13235 Nominal exchange rate dynamics and monetary policy: uncovered interest rate parity and purchasing power parity revisited

Author(s): Yossi Saadon, Nathan Sussman
Publication Date: October 2018
Date Revised: November 2020
Keyword(s): Balance sheet effects, Exchange Rates, Inflation expectations, monetary policy, purchasing power parity, uncovered interest rate parity
JEL(s): E52, F3, F31, F41, G15
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13235

The increasing globalization of trade in goods and services and the deepening of financial markets have reduced frictions that may impede the PPP and UIP relationships' operation 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, financial deepening, and developing a market for short-term inflation expectations contribute to monetary policy effectiveness.