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Monetary Policy and Exchange Rate Dynamics: New Evidence from the Narrative Approach to Shock Identification

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Abstract

We argue that endogenous and anticipated movements in interest rates lead to underestimates of the speed and magnitude of the exchange rate response to monetary policy. Employing the Romer and Romer (2004) exogenous monetary policy shock measure, we find that the effect of a one percentage point increase in the U.S. interest rate is up to twice as large and 3 times as fast as that obtained using the actual federal funds rate to identify monetary shocks. Moreover, new evidence from open economy VARs emphasises the adjustment role of the exchange rate. U.S. prices and output respond almost twice as quickly as they do in a closed economy VAR using the Romer and Romber shock measure. There is also evidence of stronger international transmission of U.S. monetary shocks. Overall, the estimated response speeds and magnitudes are more easily reconciled with existing models than previous empirical work.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2005/w18/RRFX.03.08.2005.pdf
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Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2005-W18.

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Length: 59 pages
Date of creation: 01 Aug 2005
Date of revision:
Handle: RePEc:nuf:econwp:0518

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Web page: http://www.nuff.ox.ac.uk/economics/

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Keywords: monetary policy shocks; exchange rate dynamics; open economy VARs;

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Cited by:
  1. Volha Audzei & Frantisek Brazdik, 2012. "Monetary Policy and Exchange Rate Dynamics: The Exchange Rate as a Shock Absorber," Working Papers 2012/09, Czech National Bank, Research Department.

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