How Does Uncovered Interest Rate Parity ! Work?

Uncovered Interest Rate Parity is like a game where money moves from one place to another because of interest rates.

Imagine you have two piggy banks: one in your room and one at your friend’s house. If the bank at your friend's house gives more candy for saving (that’s like higher interest rate), you might want to move some candies there to get more later.

Now, think about exchange rates, which are like the price of trading candies between piggy banks. If one piggy bank is giving more candy, people will try to move their candies there, this makes the price of moving candies change a little bit too.

Uncovered Interest Rate Parity says that if you expect the exchange rate (the price of trading candies) to stay the same, then the difference in interest rates between two places should balance out. If one place gives more candy, people will move their candies there until it feels fair again, like when you trade your toys with a friend and agree on how many stickers each toy is worth.

So, just like you might want to save at your friend’s piggy bank if it pays better, money moves between countries in the same way, because of interest rates and exchange rates!