IDEAS home Printed from https://ideas.repec.org/a/eee/jimfin/v23y2004i4p615-643.html
   My bibliography  Save this article

Overshooting and the exchange rate disconnect puzzle: a reappraisal

Author

Listed:
  • Hairault, Jean-Olivier
  • Patureau, Lise
  • Sopraseuth, Thepthida

Abstract

Transitions to floating exchange rate regimes have led to sharp increases in exchange rate volatilities with no corresponding changes in the distribution of macroeconomic fundamentals. In the spirit of Dornbusch (1976), we assess whether nominal exchange rate overshooting is responsible for this phenomenon. As long as uncovered interest rate parity holds, nominal exchange rate overshooting is linked to a persistent fall in the spread between domestic and foreign nominal interest rates. We thus develop a limited participation model in a small open economy setting. With small adjustment costs on money holdings, overshooting substantially contributes to the nominal exchange rate volatility.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Hairault, Jean-Olivier & Patureau, Lise & Sopraseuth, Thepthida, 2004. "Overshooting and the exchange rate disconnect puzzle: a reappraisal," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 615-643, June.
    • Handle: RePEc:eee:jimfin:v:23:y:2004:i:4:p:615-643
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0261-5606(04)00024-5
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Martin Eichenbaum & Charles L. Evans, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 110(4), pages 975-1009.
    2. David Andolfatto & Paul Gomme, 2003. "Monetary Policy Regimes and Beliefs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 1-30, February.
    3. Kalyvitis, Sarantis & Michaelides, Alexander, 2001. "New evidence on the effects of US monetary policy on exchange rates," Economics Letters, Elsevier, vol. 71(2), pages 255-263, May.
    4. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
    5. Hairault, Jean-Olivier & Portier, Franck, 1993. "Money, New-Keynesian macroeconomics and the business cycle," European Economic Review, Elsevier, vol. 37(8), pages 1533-1568, December.
    6. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 869-902.
    7. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 82(2), pages 346-353, May.
    8. Sims, Christopher A. & Zha, Tao, 2006. "Does Monetary Policy Generate Recessions?," Macroeconomic Dynamics, Cambridge University Press, vol. 10(2), pages 231-272, April.
    9. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412, National Bureau of Economic Research, Inc.
    10. Faust, Jon, 1998. "The robustness of identified VAR conclusions about money," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 207-244, December.
    11. King, Robert G & Watson, Mark W, 1996. "Money, Prices, Interest Rates and the Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 35-53, February.
    12. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    13. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
    14. Dow, James Jr., 1995. "The demand and liquidity effects of monetary shocks," Journal of Monetary Economics, Elsevier, vol. 36(1), pages 91-115, August.
    15. Schlagenhauf, Don E. & Wrase, Jeffrey M., 1995. "Liquidity and real activity in a simple open economy model," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 431-461, June.
    16. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
    17. Juster, F Thomas & Stafford, Frank P, 1991. "The Allocation of Time: Empirical Findings, Behavioral Models, and Problems of Measurement," Journal of Economic Literature, American Economic Association, vol. 29(2), pages 471-522, June.
    18. Jon Faust, 1998. "The robustness of identified VAR conclusions about money," International Finance Discussion Papers 610, Board of Governors of the Federal Reserve System (U.S.).
    19. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
    20. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
    21. Bonser-Neal, Catherine & Roley, V Vance & Sellon, Gordon H, Jr, 1998. "Monetary Policy Actions, Intervention, and Exchange Rates: A Reexamination of the Empirical Relationships Using Federal Funds Rate Target Data," The Journal of Business, University of Chicago Press, vol. 71(2), pages 147-177, April.
    22. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 15(Win), pages 3-34.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kollmann, Robert, 2003. "Monetary Policy Rules in an Interdependent World," CEPR Discussion Papers 4012, C.E.P.R. Discussion Papers.
    2. Diego E. Vacaflores, 2011. "Monetary Stimulus: Through Wall Street or Main Street?," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 14(1), pages 9-40, June.
    3. Karamé, Frédéric & Patureau, Lise & Sopraseuth, Thepthida, 2008. "Limited participation and exchange rate dynamics: Does theory meet the data?," Journal of Economic Dynamics and Control, Elsevier, vol. 32(4), pages 1041-1087, April.
    4. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.
    5. de Blas, Beatriz, 2010. "Exchange rate dynamics in economies with portfolio rigidities," International Review of Economics & Finance, Elsevier, vol. 19(3), pages 366-382, June.
    6. Diego E. Vacaflores, 2012. "Remittances, Monetary Policy, and Partial Sterilization," Southern Economic Journal, John Wiley & Sons, vol. 79(2), pages 367-387, October.
    7. Patureau, Lise, 2007. "Pricing-to-market, limited participation and exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3281-3320, October.
    8. Murphy, Austin, 2008. "An empirical investigation of investor expectations in the currency market," International Review of Financial Analysis, Elsevier, vol. 17(1), pages 108-133.
    9. Kollmann, Robert, 2002. "Monetary Policy Rules in a Two-Country World," MPRA Paper 70347, University Library of Munich, Germany.
    10. Murphy, Austin & Zhu, Yun (Ellen), 2008. "Unraveling the complex interrelationships between exchange rates and fundamentals," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 1150-1160, June.
    11. Lise Patureau, 2002. "Pricing-to-market and limited participation : a joint explanation to the exchange rate disconnect puzzle," Computing in Economics and Finance 2002 299, Society for Computational Economics.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Karamé, Frédéric & Patureau, Lise & Sopraseuth, Thepthida, 2008. "Limited participation and exchange rate dynamics: Does theory meet the data?," Journal of Economic Dynamics and Control, Elsevier, vol. 32(4), pages 1041-1087, April.
    2. Patureau, Lise, 2007. "Pricing-to-market, limited participation and exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3281-3320, October.
    3. Lise Patureau, 2002. "Pricing-to-market and limited participation : a joint explanation to the exchange rate disconnect puzzle," Computing in Economics and Finance 2002 299, Society for Computational Economics.
    4. de Blas, Beatriz, 2010. "Exchange rate dynamics in economies with portfolio rigidities," International Review of Economics & Finance, Elsevier, vol. 19(3), pages 366-382, June.
    5. Jon Faust & John H. Rogers & Eric Swanson & Jonathan H. Wright, 2003. "Identifying the Effects of Monetary Policy Shocks on Exchange Rates Using High Frequency Data," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1031-1057, September.
    6. Juvenal, Luciana, 2011. "Sources of exchange rate fluctuations: Are they real or nominal?," Journal of International Money and Finance, Elsevier, vol. 30(5), pages 849-876, September.
    7. Dedola, Luca & Lippi, Francesco, 2005. "The monetary transmission mechanism: Evidence from the industries of five OECD countries," European Economic Review, Elsevier, vol. 49(6), pages 1543-1569, August.
    8. Fratzscher, Marcel & Juvenal, Luciana & Sarno, Lucio, 2010. "Asset prices, exchange rates and the current account," European Economic Review, Elsevier, vol. 54(5), pages 643-658, July.
    9. Kalyvitis, Sarantis & Skotida, Ifigeneia, 2010. "Some empirical evidence on the effects of U.S. monetary policy shocks on cross exchange rates," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(3), pages 386-394, August.
    10. Benjamin Keen, 2009. "Output, Inflation, and Interest Rates in an Estimated Optimizing Model of Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 327-343, April.
    11. Jon Faust & John H. Rogers & Eric Swanson & Jonathan H. Wright, 2003. "Identifying the Effects of Monetary Policy Shocks on Exchange Rates Using High Frequency Data," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1031-1057, September.
    12. Pao-Lin Tien, 2009. "Using Long-Run Restrictions to Investigate the Sources of Exchange Rate Fluctuations," Wesleyan Economics Working Papers 2009-004, Wesleyan University, Department of Economics.
    13. Scholl, Almuth & Uhlig, Harald, 2008. "New evidence on the puzzles: Results from agnostic identification on monetary policy and exchange rates," Journal of International Economics, Elsevier, vol. 76(1), pages 1-13, September.
    14. Chung, Kyuil, 2009. "Does the liquidity effect guarantee a positive term premium?," Economic Modelling, Elsevier, vol. 26(5), pages 893-903, September.
    15. Voss, G.M. & Willard, L.B., 2009. "Monetary policy and the exchange rate: Evidence from a two-country model," Journal of Macroeconomics, Elsevier, vol. 31(4), pages 708-720, December.
    16. Rochelle M. Edge, 2000. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," International Finance Discussion Papers 673, Board of Governors of the Federal Reserve System (U.S.).
    17. Edge, Rochelle M., 2007. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1644-1669, September.
    18. Marvin J. Barth III & Valerie A. Ramey, 2002. "The Cost Channel of Monetary Transmission," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 199-256, National Bureau of Economic Research, Inc.
    19. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jimfin:v:23:y:2004:i:4:p:615-643. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/30443 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.