Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/314101 
Year of Publication: 
2020
Citation: 
[Journal:] Journal of Applied Economics [ISSN:] 1667-6726 [Volume:] 23 [Issue:] 1 [Year:] 2020 [Pages:] 450-468
Publisher: 
Taylor & Francis, Abingdon
Abstract: 
In this paper we derive a new model on exchange rate response to a lasting higher interest rate level. Contemporary models do not provide a convincing explanation for this relationship, but recent research suggests that models based on demand-pull effects to be somewhat confined to small funding cost increases. This would make cost-push effects more relevant when the interest rate differential (IRD) is larger and longer-lasting. The new model accounts for cost-push effects and suggests that a persistent higher IRD can evoke multiple responses, including currency depreciation, specialization, inflation, and wage drift. The model suggests that excessive long-lasting IRD can spark a chronic interaction between inflation and currency depreciation. Empirical data substantiate the prediction capability of the new model. We also demonstrate how the uncovered interest rate parity (UIP) principle is a special case, which can explain its empirical research anomalies, and when carry trade is a profitable investment strategy.
Subjects: 
monetary policy
carry trade
cash-in-advance
central bank policy
control rates
Exchange rate
exchange rate modeling
factor price equalization
interest rate differential
interest rates
IRD
UIP
uncovered interest rate parity
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article

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