(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