uncovered interest parity with fundamentals: a brazilian exchange rate forecast model marcelo kfoury...
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Uncovered Interest Parity with Fundamentals: A Brazilian
Exchange Rate Forecast Model
Uncovered Interest Parity with Fundamentals: A Brazilian
Exchange Rate Forecast Model
Marcelo Kfoury MuinhosPaulo Springer de Freitas
Fabio Araujo
Research Department Central Bank of Brazil
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 1 - Introduction1 - 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
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 2 – UIP and others2 – UIP and others
Survey : JP Morgan Model (2000)
Productivity, terms of trade, and trade openness
Obstfeld and Rogoff (1996) Wadhwani (1999)
),()(_
*ttttkt Zqqiie
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 3 – BCB X-Models3 – BCB X-Models
Random Walk with Monetary Surprises (RWMS)
UIP with “Rational Expectations”
UIP with “Adaptive Expectations”
tttttt xiieeE *
1
ttttttttt ixiixie )( **
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
4 – The UIP with Fundamentals
4 – The UIP with Fundamentals
IS Curve
Phillips Curve
Taylor Rule
tttttt uaiahaah 131211101 )(
ttttttt hapeaaaa 124*
2221222121 )()1(
tttt haaai 32*
3130 )(
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
4 – The UIP with Fundamentals
4 – The UIP with Fundamentals
The UIP with Fundamentals
is the exchange rate that should clear BP at t + K.
1* )(
K
njKttjtjtjttntt eExiiEeE
jjj PyQBC ).,(.
BKBSBCBP
Ktt eE
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
4 – The UIP with Fundamentals
4 – The UIP with Fundamentals
Solving the system Balance of payment clears at time
t+K
Linear equations: 11 K - 1
Non-linear trade balance equation
At t+1, taken values at t as given
Deviation from equilibrium
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 - Simulations UIP - 12 x 4 periods
5 - Simulations UIP - 12 x 4 periods
Interest Response to Inflation Shock
0.000
0.004
0.008
0.012
0.016
1 7 13
19
25
31
37
43
49
55
61
67
i 4 i 12
Inflation Response to Inflation Shock
0.000
0.004
0.008
0.012
1 6 11
16
21
26
31
36
41
46
51
56
61
66
71
pi 4 pi 12
Output Gap Resp to Inflation Shock
-0.003
-0.002
-0.001
0.000
1 7
13
19
25
31
37
43
49
55
61
67
h 4 h 12
Real Exchange Resp to Inflation Shock
-0.040
-0.030
-0.020
-0.010
0.000
1 7
13
19
25
31
37
43
49
55
61
67
73
real exch (4) real exch (12)
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP with and without real exchange
in IS
5 – UIP with and without real exchange
in IS
Interest Response to Inflation Shock
0.000
0.004
0.008
0.012
0.016
1 7 13
19
25
31
37
43
49
55
61
67
73
79
i without real exch i with real exch
Inflation Response to Inflation Shock
0.000
0.004
0.008
0.012
1 6 11
16
21
26
31
36
41
46
51
56
61
66
71
pi without real exch pi with real exch
Output Gap Resp to Inflation Shock
-0.003
-0.002
-0.001
0.000
1 7
13
19
25
31
37
43
49
55
61
67
h without real exch h with real exch
Real Exchange Resp to Inflation Shock
-0.040
-0.030
-0.020
-0.010
0.000
1 7
13
19
25
31
37
43
49
55
61
67
73
real exch without real exch with
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – Random Walk with and without real exch. in
IS
5 – Random Walk with and without real exch. in
ISInterest Response to Inflation Shock
-0.004
0.000
0.004
0.008
0.012
0.016
1 7 13 19 25 31 37 43 49 55 61 67 73 79RW without real exch RW with real exch
Inflation Response to Inflation Shock
-0.004
0.000
0.004
0.008
0.012
1 7 13 19 25 31 37 43 49 55 61 67 73 79
rw without real exch rw with real exch
Output Gap Resp to Inflation Shock
-0.003
-0.002
-0.001
0.000
1 7
13 19 25 31 37 43 49 55 61 67 73 79
rw withouht rw with
Real Exchange Resp to Inflation Shock
-0.090-0.080-0.070-0.060-0.050-0.040-0.030-0.020-0.0100.000
1 7
13 19 25 31 37 43 49 55 61 67 73 79
rw without rw with
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to inflation
shock)
5 – UIP & RW(resp. to inflation
shock) Interest Response to Inflation Shock
-0.005
0.000
0.005
0.010
0.015
0.020
1 7 13
19
25
31
37
43
49
55
61
67
73
79
UIP RW
Inflation Response to Inflation Shock
-0.0020.0000.0020.0040.0060.0080.0100.012
1 7 13
19
25
31
37
43
49
55
61
67
73
79
UIP RW
Output Gap Resp to Inflation Shock
-0.003
-0.003
-0.002
-0.002
-0.001
-0.001
0.000
1 7
13
19
25
31
37
43
49
55
61
67
UIP RW
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to inflation
shock)
5 – UIP & RW(resp. to inflation
shock) Real Exchange Resp to Inflation Shock
-0.060
-0.050
-0.040
-0.030
-0.020
-0.010
0.000
1 7
13 19 25 31 37 43 49 55 61 67 73 79
UIP RW
Nom Exch Rate Resp to Infl Shock
-0.050
0.000
0.050
0.100
0.150
0.200
1 7 13 19 25 31 37 43 49 55 61 67 73 79UIP RW
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to interest rate
shock)
5 – UIP & RW(resp. to interest rate
shock) Interest Response to Interest Shock
-0.004-0.0020.0000.0020.0040.0060.0080.0100.012
1 7 13
19
25
31
37
43
49
55
61
67
73
79
UIP RW
Inflation Response to Interest Shock
-0.001
-0.001
0.000
0.001
0.001
1 7 13
19
25
31
37
43
49
55
61
67
73
79
UIP RW
Output Gap Resp to Interest Shock
-0.005
-0.004
-0.003
-0.002
-0.001
0.000
0.001
1 7
13
19
25
31
37
43
49
55
61
67
73
UIP RW
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to interest rate
shock)
5 – UIP & RW(resp. to interest rate
shock) Real Exchange Resp to Interest Shock
-0.010
-0.005
0.000
0.005
0.010
1 7
13
19
25
31
37
43
49
55
61
67
73
79
UIP RW
Nominal Exchange Rate Resp to Interest Shock
-0.025-0.020-0.015-0.010-0.0050.0000.0050.010
1 7 13 19 25 31 37 43 49 55 61 67 73 79
UIP RW
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to output gap
shock)
5 – UIP & RW(resp. to output gap
shock) Interest Resp. to Output Gap Shock
-0.002
0.000
0.002
0.004
0.006
0.008
1 7 13
19
25
31
37
43
49
55
61
67
73
79
i uip i rw
Inflation Resp. to Output Gap Shock
-0.002-0.001-0.0010.0000.0010.0010.0020.002
1 7 13
19
25
31
37
43
49
55
61
67
73
79
pi uip pi rw
Output Gap Resp. to Output Gap Shock
-0.002
0.000
0.002
0.004
0.006
0.008
0.010
0.012
1 7 13
19
25
31
37
43
49
55
61
67
73
79
h uip h rw
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil
5 – UIP & RW(resp. to output gap
shock)
5 – UIP & RW(resp. to output gap
shock)
Real Exchange Resp to Interest Shock
-0.010
-0.005
0.000
0.005
0.010
1 7
13
19
25
31
37
43
49
55
61
67
73
79
Real Exch. Resp. to Output Gap Shock
-0.020
-0.015
-0.010
-0.005
0.000
1 7 13
19
25
31
37
43
49
55
61
67
73
79
teta uip teta rw
Nom. Exch. Resp. to Output Gap Shock
-0.020-0.0100.0000.0100.0200.0300.0400.0500.060
1 7 13
19
25
31
37
43
49
55
61
67
73
79
e uip e rw
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 5 – UIP & RW
(resp. to risk shock) 5 – UIP & RW
(resp. to risk shock) Interest Response to Risk Shock
-0.010
-0.005
0.000
0.005
0.010
0.015
1 2 3 4 5 6 7 8 9 10 11 12 13UIP RW
Inflation Response to Risk Shock
-0.006-0.004-0.0020.0000.0020.0040.0060.0080.010
1 2 3 4 5 6 7 8 9 10 11 12 13UIP RW
Output Gap Response to Risk Shock
-0.002
-0.002
-0.001
-0.001
0.000
0.001
0.001
1 2 3 4 5 6 7 8 9 10 11 12 13UIP RW
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 5 – UIP & RW
(resp. to risk shock) 5 – UIP & RW
(resp. to risk shock)
Nom Exch Rate Resp to Risk Shock
-0.0200.0000.0200.0400.0600.0800.1000.120
1 2 3 4 5 6 7 8 9 10 11 12 13
UIP RW
Real Exch Rate Resp to Risk Shock
-0.020
0.000
0.020
0.040
0.060
0.080
0.100
1 2 3 4 5 6 7 8 9 10 11 12 13
teta uip teta rw
Research Department – Central Bank of Brazil
One Year of Inflation Targeting in Brazil 6 - Conclusion6 - Conclusion
UIP with Fundamentals & RWMS
Expected time to clear the BP
Extensions