US monetary policy uncertainty and RMB deviations from covered interest parity

Abstract

This paper examines how US monetary policy uncertainty (MPU) affects RMB deviations from covered interest parity (CIP) and how this effect is influenced by China’s capital controls, the RMB exchange rate regime, and international reserves that constrain the transmitting channel of US MPU shocks. Our findings show that US MPU has a spill-over effect and creates deviations from RMB CIP. Capital controls insulate uncertainty shocks and alleviate the US MPU spill-over effect. There are some evidence that international reserves alleviate and the liberalised RMB exchange rate regime magnifies the spill-over effect. However, their effects become insignificant in the presence of capital controls. Moreover, the US MPU effect on RMB CIP deviations becomes prominent after the 2008 global financial crisis.