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Monetary policy responses to the exchange rate: Empirical evidence from the ECB

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  • Demir, İshak

Abstract

The exchange rate is an important part of the transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. It can be difficult to measure the reaction of monetary policy to the movements of the exchange rate, due to the simultaneous response of monetary policy to the exchange rate and the possibility that both variables respond to several other variables. This study addresses these problems by using an identification method based on the heteroscedasticity in the high-frequency data. The results in this paper suggest that the ECB systematically responds to exchange rate movements but that quantitative effects are small. Such a significant but small reaction coefficient seems consistent with the hypothesis that the central banks do not target the fluctuations in the exchange rate but consider them only to the extent they impact on the expected inflation and output path.

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  • Demir, İshak, 2014. "Monetary policy responses to the exchange rate: Empirical evidence from the ECB," Economic Modelling, Elsevier, vol. 39(C), pages 63-70.
  • Handle: RePEc:eee:ecmode:v:39:y:2014:i:c:p:63-70
    DOI: 10.1016/j.econmod.2014.02.024
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    7. Miah, Fazlul & Khalifa, Ahmed Ali & Hammoudeh, Shawkat, 2016. "Further evidence on the rationality of interest rate expectations: A comprehensive study of developed and emerging economies," Economic Modelling, Elsevier, vol. 54(C), pages 574-590.
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    More about this item

    Keywords

    Monetary policy; Exchange rates; Identification through heteroscedasticity; European Central Bank; Monetary policy reaction;
    All these keywords.

    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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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