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

Publication Date

10/10/2018

JEL Code(s)

Keyword(s)

Programme Area(s)

Network(s)

Abstract

The increasing globalization of trade in goods and services and the deepening of financial markets have reduced frictions that may impede the operation of the PPP and UIP relationships 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 and financial deepening contribute to the effectiveness of monetary policy.