Uncovered Interest Parity with Fundamentals: A Brazilian Exchange Rate Forecast Model

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Uncovered Interest Parity with Fundamentals A
Brazilian Exchange Rate Forecast Model

• Marcelo Kfoury Muinhos
• Paulo Springer de Freitas
• Fabio Araujo
• Research Department
• Central Bank of Brazil

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1 - Introduction

• Motivation
• The most challenging topic
• Pass-through
• UIP, PPP and Random Walk
• Objetives of the Paper
• UIP with a equilibrium exchange rate that clears
  the Balance of Payments

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2 UIP and others

• Survey
• JP Morgan Model (2000)
• Productivity, terms of trade, and trade openness
• Obstfeld and Rogoff (1996)
• Wadhwani (1999)

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3 BCB X-Models

• Random Walk with Monetary Surprises (RWMS)
• UIP with Rational Expectations
• UIP with Adaptive Expectations

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4 The UIP with Fundamentals

• IS Curve
• Phillips Curve
• Taylor Rule

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4 The UIP with Fundamentals

• The UIP with Fundamentals
• is the exchange rate that should clear BP
  at t K.

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4 The UIP with Fundamentals

• Solving the system
• Balance of payment clears at time tK
• Linear equations 11 K - 1
• Non-linear trade balance equation
• At t1, taken values at t as given
• Deviation from equilibrium

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5 - Simulations UIP - 12 x 4 periods
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5 UIP with and without real exchange in IS
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5 Random Walk with and without real exch. in IS
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5 UIP RW(resp. to inflation shock)
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5 UIP RW(resp. to inflation shock)
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5 UIP RW(resp. to interest rate shock)
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5 UIP RW(resp. to interest rate shock)
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5 UIP RW(resp. to output gap shock)
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5 UIP RW(resp. to output gap shock)
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5 UIP RW(resp. to risk shock)
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5 UIP RW(resp. to risk shock)
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6 - Conclusion

• UIP with Fundamentals RWMS
• Expected time to clear the BP
• Extensions