Delayed Overshooting: The Case for Information Rigidities

Abstract

We provide evidence that the delayed overshooting puzzle reflects a slow adjustment of exchange rate expectations to monetary policy shocks rather than a failure of uncovered interest parity. Consistent with this evidence, we put forward a New Keynesian model in which uncovered interest parity holds, but there are information rigidities: investors do not observe monetary policy shocks but learn rationally from unanticipated shifts in monetary policy about the state of the economy. We estimate the model and find it can account for the joint responses of the spot exchange rate, forward exchange rates, and excess currency returns to monetary policy shocks. (JEL D83, E12, E31, E43, E52, F31)