Working Paper: CEPR ID: DP13235
Authors: Yossi Saadon; Nathan Sussman
Abstract: The increasing globalization of trade in goods and services and the deepening of financial markets have reduced frictions that may impede the PPP and UIP relationships' operation in the short run. In this paper, we estimate the short term relative PPP and UIP relationships. Using data from Israel, which has a deep market for inflation expectations for 12 months, we show that relative PPP and UIP cannot be rejected. Deviations from equilibrium last less than a year. Data from Israel’s capital account of the balance of payments shows that the deviations are not destabilizing. Our findings suggest that greater globalization, financial deepening, and developing a market for short-term inflation expectations contribute to monetary policy effectiveness.
Keywords: purchasing power parity; uncovered interest rate parity; exchange rates; monetary policy; inflation expectations; balance sheet effects
JEL Codes: F3; F31; F41; G15; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| percentage change in the Israeli new shekel (NIS) against the US dollar (F31) | inflation expectations differential (E31) |
| yield difference between Bank of Israel bonds and US Treasuries (E43) | expected change in the exchange rate (F31) |
| inflation expectations differential (E31) | percentage change in the Israeli new shekel (NIS) against the US dollar (F31) |
| expected change in the exchange rate (F31) | yield difference between Bank of Israel bonds and US Treasuries (E43) |