Monetary policy and the exchange rate

Abstract

This paper analyses the implications of uncovered interest parity for departures of the exchange rate from purchasing power parity as a result of temporary policy‐induced changes in the domestic interest rate. The analysis produces a precise formula for the relationship, which suggests that exchange rate movements caused by monetary policy are small relative to the size of swings in the value of the New Zealand dollar during the 1990s. Thus it is both wrong to hold the Reserve Bank responsible for these swings in the past and unrealistic to expect monetary policy to eliminate such swings in the future.

Notes

Professor of Economics, Commerce Division, P.O. Box 84, Lincoln University Post Office, Canterbury, E‐mail: [email protected]