How does monetary policy respond to exchange rate
Abstract
This paper analyzes how monetary policy has responded to exchange rate movements
in six open economies, paying particular attention to the two-way interaction between monetary policy and the exchange rate. We address this issue using a structural VAR model
that is identifyed using a combination of sign and short-term (zero) restrictions. Our suggested identification scheme allows for a simultaneous reaction between the interest rates
and the exchange rate. Doing so we find that, while there is a instantaneous reaction in the
exchange rate following a monetary policy shock in all countries, monetary policy responds
on impact to an exchange rate shock in only four of the six countries. While this suggests
that the exchange rate is not equally important in the interest rate setting in all countries,
we find that accounting for a potential interaction is still crucial when identifying monetary
policy shocks in open economies structural VARs.
Description
1/2010 and 2/2010 was published as CAMAR Working Papers Series (ISSN 1892-2198). From 2011 the series' name changed to CAMP Working Paper Series (ISSN 1893-4811).