(Economists call this "uncovered
interest parity.")
The Dodd-Frank legislation contains rules that have impeded the functioning of the international monetary market: by raising US dollar funding costs for foreign banks, the rule compromised so-called covered
interest parity. For Japan, this undermined the transmission of monetary easing in international financial markets - a mechanism that was already strained by risk-averse investors flocking to the Japanese yen as a safe-haven currency.
Das (1985), "Transaction Costs and
Interest Parity Theorem," Journal of Political Economy 93(4): 793-799.
Moreover Boschen, Smith (2012) conclude that because of the structural changes in the foreign exchange market, uncovered
interest parity might hold better in the future.
The uncovered
interest parity (UIP) condition states that the interest rate differential between two currencies will be offset by an equal rate of depreciation of the higher-yielding currency against the lower-yielding currency.
* Shin-ichi Fukuda, "Strong Sterling Pound and Weak European Currencies in the Crises: Evidence from Covered
Interest Parity of Secured Rates" (NBER Working Paper No.
Mihov and Santacreu (2013) argue that the costs and benefits of an IRR versus those of an ERR depend on two factors: the actual implementation of the policy and whether the uncovered
interest parity (UIP) condition holds.
Cointegrating vectors are uniquely identified by imposing structural economic restrictions on purchasing power parity (PPP), uncovered
interest parity (U1P) and current account balance.
Exchange Rate Economics: The Uncovered
Interest Parity Puzzle and Other Anomalies
The conventional view is that uncovered
interest parity (UIP) and PPP are appealing in theory but rejected empirically.
[1.] Bahmani-Oskooee, Mohsen and Das, Satya (1985), "Transaction Costs and the
Interest Parity Theorem", in Journal of Political Economy, August 1985, 793-99
