Exchange rates

Eleonora Granziera, Markus Sihvonen, 26 November 2020

High short-term interest rates predict domestic currency appreciation and low excess returns for long-term bonds. These facts are at odds with two textbook conditions describing the relationship between different maturity interest rates and exchange rates: uncovered interest parity (UIP) and the expectations hypothesis. This column explains that both conditions can be reconciled with the data if agents are assumed to have sticky rather than perfectly rational expectations concerning short rates. It also demonstrates how this empirically motivated change in model assumptions has broad implications for interpreting the effects of monetary policy on exchange rates and yield curves.  

Sebastian Edwards, 10 November 2020

While today almost every advanced nation has a flexible exchange rate regime similar to that advocated by Milton Friedman, most emerging countries continue to have ‘conventional peg’. This column draws on the historical work of Milton Friedman to examine the conditions under which he thought that flexible rates were the right system for developing countries, and when he thought that it was appropriate to have an alternative regime. 

Puriya Abbassi, Falk Bräuning, 31 October 2020

The recent and persistent failure of covered interest parity is inconsistent with the standard view of international finance textbooks. Current thinking relates this violation mostly to supply-side effects. This column argues that demand effects associated with banks’ management of foreign exchange exposure are also an important but are often overlooked driver. This result has implications for the current policy debate concerning global funding and foreign exchange markets, as well as the important role of the US dollar in international finance and banking.

Luca Dedola, Georgios Georgiadis, Johannes Gräb, Arnaud Mehl, 21 October 2020

Since the onset of the Global Crisis in 2008, central banks around the world have rolled out a broad array of quantitative easing measures, resulting in dramatic expansions of their balance sheets. This column reveals that that these policies have had large and persistent effects on the dollar/euro exchange rate, mainly through shifts in exchange rate risk and short-term interest rates between the two currencies. Changes in expectations about the future monetary policy stance also affect the response of the dollar/euro exchange rate to quantitative easing.

Emine Boz, Camila Casas, Georgios Georgiadis, Gita Gopinath, Helena Le Mezo , Arnaud Mehl, Tra Nguyen, 09 October 2020

Most global trade transactions are invoiced in just a few currencies, regardless of the countries involved in the transaction. This column presents a new dataset that offers a comprehensive and up-to-date understanding of trade invoicing patterns within the major currencies. It finds that vehicle currency use has been on the rise, with dollar invoicing increasing over time despite the decline in the share of global trade accounted for by the US, and euro invoicing also rising among certain countries (typically at the expense of the dollar). 

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