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  • Definition of Uncovered Interest Parity (UIP) Condition

  • Long-Run Equilibrium: Linking Interest Differentials to Inflation Differentials via UIP

Calculating the Long-Run Equilibrium Home Policy Rate

In a long-run equilibrium where Uncovered Interest Parity (UIP) holds, the home policy rate must be consistent with the foreign policy rate, inflation targets, and market expectations of currency depreciation. For instance, if the foreign (US) policy rate (i∗i^*) is 4% and the expected depreciation of the home currency (South African rand) is 2.5% (a value consistent with inflation target differentials), the home policy rate (ii) must be 6.5%. This is calculated as i=i∗+δE=4%+2.5%=6.5%i = i^* + \delta^E = 4\% + 2.5\% = 6.5\%.

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