NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Steve Pak Yeung Wu

Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI 53706-1393

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NBER Working Papers and Publications

December 2018Liquidity and Exchange Rates: An Empirical Investigation
with Charles Engel: w25397
We find strong empirical evidence that economic fundamentals can well account for nominal exchange rate movements. The important innovation is that we include the liquidity yield on government bonds as an explanatory variable. We find impressive evidence that changes in the liquidity yield are significant in explaining exchange rate changes for all of the G10 countries. Moreover, after controlling for liquidity yields, traditional determinants of exchange rates – adjustment toward purchasing power parity and monetary shocks – are also found to be economically and statistically significant. We show how these relationships arise out of a canonical two-country New Keynesian model with liquidity returns. Additionally, we find a role for sovereign default risk and currency swap market frictions...
November 2017The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules
with Charles Engel, Dohyeon Lee, Chang Liu, Chenxin Liu: w24059
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 accoun...

Published: Charles Engel & Dohyeon Lee & Chang Liu & Chenxin Liu & Steve Pak Yeung Wu, 2018. "The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules," Journal of International Money and Finance, . citation courtesy of

 
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