NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Chang Liu

Department of Economics
University of Wisconsin-Madison
1180 Observatory Drive
Madison, WI 53706-1393
Tel: 6088867658

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Institutional Affiliation: University of Wisconsin-Madison

NBER Working Papers and Publications

November 2017The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules
with Charles Engel, Dohyeon Lee, Chenxin Liu, Steve Pak Yeung Wu: 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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