The empirical VAR literature on the monetary transmission mechanism in open economies has not yet provided a commonly accepted solution to the problem of simultaneity between interest rates and the exchange rate. In this paper we propose to solve the identification problem by using information extracted from financial markets independently from the VAR to measure monetary policy shocks. We also evaluate the relative importance of macroeconomic and monetary policy variables in explaining short-term fluctuations in the nominal exchange rate. Our main results are that the simultaneity between German policy rates and the US\ dollar/D Mark exchange rate is not an empirically relevant problem, and that monetary variables are dominated by macroeconomic factors in the explanation of exchange rate fluctuations.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2079.
Find related papers by JEL classification: E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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