TITLE:
Forward Bias, Uncovered Interest Parity and Related Puzzles
AUTHORS:
John Pippenger
KEYWORDS:
Risk Premiums, Rational Expectations, Uncovered Interest Parity, Interven-tion, Covered Interest Parity, Forward Bias, Liquidity Effects
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.12,
September
19,
2018
ABSTRACT: Uncovered interest parity is widely used in open
economy macroeconomics. But when exchange rates are flexible the evidence
rejects UIP and implies forward bias. There are many suggested explanations for
this failure of UIP and forward bias, but none are widely accepted, at least
partially because none appear to explain the related puzzles discussed below.
This article shows how sterilized “leaning against the wind” and a combination
of the inflationary and liquidity effects associated with open market
operations can explain forward bias and the failure of UIP even when
expectations are rational. They also appear to be able to explain the related
puzzles.