Liquidity premia, interest rates and exchange rate dynamics
Loading...
Date
2011-04-12
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Abstract
Empirical failure of uncovered interest rate parity (UIP) has become a stylized
fact. VARs by Eichenbaum and Evans (1995) and Scholl and Uhlig (2008)
find delayed overshooting of the exchange rate in response to a monetary
shock. This result contradicts Dornbusch’s (1976) original overshooting, which
is based on UIP. This paper presents a model in which assets eligible for central
bank’s open market operations, such as government bonds, command liquidity
premia. Further, I allow for a key currency which is required to participate in
international goods trade. Therefore, assets allowing access to key currency
liquidity are held by agents around the globe. I show that liquidity premia
lead to a modified UIP condition. In response to a monetary policy shock,
the model predicts delayed overshooting of the nominal exchange rate, as in
Eichenbaum and Evans (1995).
Description
Table of contents
Keywords
monetary policy, uncovered interest rate parity, liquidity premium, key currency