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Bond market co-movements, expected inflation and the GBP-USD equilibrium real exchange rate

Macchiarelli, Corrado (2014) Bond market co-movements, expected inflation and the GBP-USD equilibrium real exchange rate. Quarterly Review of Economics and Finance, 54 (2). pp. 242-256. ISSN 1062-9769

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Identification Number: 10.1016/j.qref.2013.10.008

Abstract

Since the end of the fixed rates in 1973 and after the European Monetary System (EMS) sterling dismissal in 1992, the value of the pound has undergone large cyclical fluctuations on average. Of particular interest to policy makers is the understanding of whether such movements are consistent with the lack or not of a correction mechanism to some long-run equilibrium. The purpose of the present study is to understand those dynamics, how the external value of the British sterling (GBP) relative to the US dollar (USD) evolved during the recent floating experiences, and what have been the driving forces. In this paper we assume the real exchange rate to be determined by forces relating to the goods and capital market in a general equilibrium framework. This entails testing the purchasing power parity (PPP) and the uncovered interest parity (UIP) together. In doing so, we model inflation expectations explicitly. Our findings have two important implications, both for monetary policy. First, we show that some of the observed changes in the bilateral real exchange rate cannot be solely attributed to changes in inflation rates, but, also to capital markets. Secondly, we find a weaker behavior of the US bond rate on international markets, possibly explained by the special US dollar status of World reserve currency.

Item Type: Article
Official URL: http://www.journals.elsevier.com/the-quarterly-rev...
Additional Information: © 2013 The Board of Trustees of the University of Illinois
Divisions: European Institute
Subjects: H Social Sciences > HG Finance
JEL classification: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level; Inflation; Deflation
Sets: Departments > European Institute
Date Deposited: 03 Jun 2014 14:52
Last Modified: 20 Mar 2019 02:25
URI: http://eprints.lse.ac.uk/id/eprint/56943

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