Discussion Papers 2016

CIRJE-F-1032

"Monetary Policy and Covered Interest Parity in the Post GFC Period: Evidence from the Australian Dollar and the NZ Dollar"

Author Name

Fukuda, Shin-ichi and Mariko Tanaka

Date

November 2016

Full Paper

PDF File

Remarks

Subsequently published in Journal of International Money and Finance, 2017, Volume 74, pp.301–317.

Abstract

Unlike the other major currencies, the Australian Dollar and the NZ dollar had lower interest rate than the US dollar on forward contract in the post GFC period. The purpose of this paper is to explore why this happened through estimating the covered interest parity (CIP) condition. In the analysis, we focus on a unique feature of Australia and New Zealand where short-term interest rates remained significantly positive even after the GFC. The paper first constructs a theoretical model where increased liquidity risk causes deviations from the CIP condition. It then tests this theoretical implication by using daily data of six major currencies. We find that both money market risk measures and policy rates had significant effects on the CIP deviations. The result implies that unique monetary policy feature in Australia and New Zealand made deviations from the CIP condition distinct on the forward contract.

Keywords: covered interest parity, monetary policy, global financial crisis