A VAR analysis for the uncovered interest parity and the ex-ante purchasing power parity: the role of macroeconomic and financial information

This study revisits the relation between the uncovered interest parity (UIP), the ex ante purchasing power parity (EXPPP) and the real interest parity (RIP) using a VAR approach for the US dollar, the British sterling and the Japanese yen interest rates, exchange rates and changes in prices. The original contribution is on developing some joint coefficient-based tests for the three parities conditions at a long horizon. Particularly, test results are derived by rewriting the UIP, the EXPPP and the RIP as a set of cross-equation restrictions in the VAR (see also Campbell and Shiller, 1987; Bekaert and Hodrick, 2001; and Bekaert et al., 2007; King and Kurmann, 2002). Consistent with the idea of some form of proportionality among the above three parities, we find a ”forward premium” bias in both the UIP - as it is normally found in empirical analysis (e.g. Fama, 1987) - and the ex ante PPP. The latter result is new in the literature and stems from testing the PPP in expectational terms, thus assuming agents to bear on the uncertainty of future exchange rate changes and inflation dynamics. The overall results confirm the UIP to be currency-based (see also Bekaert et al., 2007) and the EXPPP to be horizon-dependent (see also Lothian and Taylor, 1996; Taylor, 2002). Moreover, we find (weak) evidence that conditioning the VAR on variables having a strong forward-looking component (i.e. share prices) helps recover a unitary coefficient in the UIP equation. JEL Classification: E31, E43, E44, F31, C58international parity conditions, PPP, RIP, UIP

Bond market co-movements, expected inflation and the equilibrium real exchange rate

Since the end of the fixed rates in 1973 and after the EMS sterling dismissal in 1992, the value of the pound has undergone large cyclical fluctuations on average. Of particular interest to policy makers is the understanding of whether such movements are consistent with the lack or not of a correction mechanism to some long-run equilibrium. The purpose of the present study is to understand those dynamics, how the external value of the British sterling relative to the USD evolved during the recent floating experiences, and what have been the driving forces. In this paper we assume the real exchange rate to be determined by forces relating to the goods and capital market in a general equilibrium framework. This entails testing the purchasing power parity and the uncovered interest parity together. Our findings have two important implications, both for monetary policy. First, we show that some of the observed changes in the real exchange rates can not be solely attributed to changes in inflation rates, but, possibly, also to investors’ behavior. Secondly, we show that the special US dollar status of World reserve currency results into a weaker behavior of the US bond rate on international markets. JEL Classification: E31, E43, E44, F31, C58international parity conditions, PPP, RIP, UIP

Tackling the free rider problem in the EMU does not have to be a zero-sum game: Italy’s budget deficit case

Italy’s government and the European Commission continue to be locked in a standoff over the Italian budget. Corrado Macchiarelli writes that while the budget plan is badly designed and must be addressed, there is also clearly a need for euro area reforms and more mutual recognition. Ultimately the Economic and Monetary Union is facing a political problem and the current approach to the Italian crisis is not going to aid the popularity of either the EU or the single currency

What is the EU-UK relation all about? Tracking the path from monetary integration to “ever closeness”. LEQS Paper No. 137/2018 September 2018

The history of European integration has been characterized by several ‘stops-and-goes’ with considerable support on political grounds. In this paper, we discuss the role of European integration for the future of the EU-UK relations. Integration, consistent with the idea of ‘completing’ the European Monetary Union (hence, a ‘Genuine Economic and Monetary Union’- GEMU), will have the obvious consequence of affecting the UK as well and the future of its negotiations with the EU. Provided that European integration worked in the past, the net benefits of staying out of the EU exante may be different from the same benefits ex-post, particularly in the likely scenario that the Union will have to ‘comprehensively’ move towards a GEMU to safeguard its integrity

Covid-19 and term premia: a relationship worth watching

What has happened to the bond market since the start of the pandemic? Term premia spiked in March but have since recovered to their previous levels. This is the case even though uncertainty remains high. But Corrado Macchiarelli (NIESR) says their link with monetary policy is worth watching

The Ukraine war intensifies the dilemma facing monetary policymakers by simultaneously harming growth and exacerbating already high inflation

Russia’s war in Ukraine, in addition to being a human tragedy, represents a challenge for the global economy. It calls into question monetary policymakers’ strategy since it will simultaneously harm growth and put upward pressure on inflation when inflation is already high due to the pandemic. Based on estimates from the National Institute of Economic and Social Research (NIESR), Corrado Macchiarelli gives an account of what the conflict means for inflation and the challenges it poses for monetary policymakers, including in the UK

Financial (in)stability, low interest rates and (un)conventional monetary policy: potential risks and policy measures

Since the advent of the global financial crisis of 2007–08, major central banks in advanced economies - the US Fed, the Bank of England, the Bank of Japan and the ECB - have undertaken monetary policies with a view to keep interest rates low. They have also significantly expanded the monetary base (and their balance sheets) through the adoption of unconventional monetary policies, although at different times and in different forms. Several years of unconventional monetary policies and exceptionally low interest have improved banks’ health, eased credit conditions and, ultimately, helped supporting the economy. However, these policies may have undesirable side- effects that could put financial stability at risk the longer they are in place. Against this background, this paper discusses the main threats to financial stability potentially triggered by unconventional monetary policies, especially in an environment of low interest rates, analyse the interrelation between financial stability and monetary policy at the current juncture and briefly assess the viability of specific measures that could prove helpful to contain such risks, given the current institutional framework

Quantitative easing: to deal with the root of the problem, the ECB should tackle non-performing loans

Quantitative Easing (QE) – the unconventional form of monetary policy by which a central bank creates new money electronically to buy financial assets, thus helping to increase private sector spending and lower inflation – has been used by the European Central Bank (ECB) in the past. It is widely expected that an extension of the current QE programme will be announced during the ECB Governing Council meeting today, 10 March. What are the implications, and what are the risks? Eddie Gerba and Corrado Macchiarelli argue that the most effective way to deal with the root of the problem would be to accelerate the resolution of Non-Performing Loans (NPLs)

How the Eurozone’s core versus periphery pattern evolved over time

Eurozone core dynamics is key to find a way out of the current crisis, write Nauro Campos and Corrado Macchiarell

Brexit threatens the City's future in European payment systems

Future UK-EU relations are about to be negotiated in Brussels. While there are signs of improvement in many important policy areas such as citizens' rights, the financial settlement, and the impact of Brexit on the island of Ireland, little progress has been made on the role of the City as the location of Europe's major clearing house, which is represented by the London Clearing House (LCH) and owned by the London Stock Exchange, write Corrado Macchiarelli (Brunel/LSE) and Mara Monti (LSE)