Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Saturday, November 04, 2006

Where Oh Where Is My Foreign Exchange Uncovered Interest Parity?

Uncovered interest parity. The world would be a much more comprehensible place if uncovered interest parity held.

Mark Thoma quotes Brad Setser:

Brad Setser is also puzzled:

The club of puzzled dollar bears grows bigger, by Brad Setser: I am -- and probably always will be -- a big Robert Rubin fan.... [A]ll those of us who thought there was a big risk that the US would have a Wile E. Coyote moment two years ago can take comfort that both Bob Rubin and Paul Volcker thought so too....

I share Rubin's deep sense of puzzlement. Not about the dollar. Central banks are clearly responsible for propping it up.... [W]hat really puzzles me is the absence of volatility in the foreign exchange market.... I would expect, based on the collapse of capital flows to emerging economies in the 1990s, that a more unbalanced world will prove, over time, to be a more volatile world. But so far, though, it has been -- at least in some key markets -- a less volatile world. That puzzles me....

But at least I seem to be in good company...

Could the U.S. continue to spend $800 billion a year more than it makes for a long time to come? Yes. Is that the way to bet? No. The market should be pricing in a high probability of a steep fall in the U.S. trade deficit over the next five years--and if the trade deficit does fall, being short dollars will be a very good bet.

But uncovered interest parity does not hold in the world we live in. And that makes life so very confusing.


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