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How does monetary policy respond to exchange rate movements? New international evidence

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  • Hilde C. Bjørnland

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  • Jørn I. Halvorsen

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 identified 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.

Suggested Citation

  • Hilde C. Bjørnland & Jørn I. Halvorsen, 2010. "How does monetary policy respond to exchange rate movements? New international evidence," Working Papers No 1/2010, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
  • Handle: RePEc:bny:wpaper:0001
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    Citations

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    Cited by:

    1. Renée Fry & Adrian Pagan, 2011. "Sign Restrictions in Structural Vector Autoregressions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 49(4), pages 938-960, December.
    2. Ragna Alstadheim & Hilde C. Bjørnland & Junior Maih, 2013. "Do central banks respond to exchange rate movements? A Markov-switching structural investigation," Working Paper 2013/24, Norges Bank.
    3. Hoda Selim, 2012. "Exploring the Role of the Exchange Rate in Monetary Policy in Egypt," Working Papers 733, Economic Research Forum, revised 2012.
    4. Erdem Ekrem & Kayhan Selim, 2011. "The Taylor Rule in Estimating the Performance of Inflation Targeting Programs: The Case of Turkey," Global Economy Journal, De Gruyter, vol. 11(1), pages 1-17, March.
    5. K. Istrefi & B. Vonnak, 2015. "Delayed Overshooting Puzzle in Structural Vector Autoregression Models," Working papers 576, Banque de France.
    6. Fisher, Lance A. & Huh, Hyeon-seung, 2016. "Monetary policy and exchange rates: Further evidence using a new method for implementing sign restrictions," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 177-191.
    7. Jääskelä, Jarkko P. & Jennings, David, 2011. "Monetary policy and the exchange rate: Evaluation of VAR models," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1358-1374.
    8. Max Hanisch, 2017. "US Monetary Policy and the Euro Area," Discussion Papers of DIW Berlin 1701, DIW Berlin, German Institute for Economic Research.
    9. Jørn Inge Halvorsen & Dag Henning Jacobsen, 2009. "Are bank lending shocks important for economic fluctuations?," Working Paper 2009/27, Norges Bank.
    10. Bjørnland, Hilde C. & Jacobsen, Dag Henning, 2010. "The role of house prices in the monetary policy transmission mechanism in small open economies," Journal of Financial Stability, Elsevier, vol. 6(4), pages 218-229, December.
    11. Elekdag, Selim & Han, Fei, 2015. "What drives credit growth in emerging Asia?," Journal of Asian Economics, Elsevier, vol. 38(C), pages 1-13.
    12. Halvorsen, Jørn I. & Jacobsen, Dag Henning, 2014. "How important can bank lending shocks be for economic fluctuations?," The North American Journal of Economics and Finance, Elsevier, vol. 29(C), pages 104-123.
    13. repec:eee:pacfin:v:46:y:2017:i:pb:p:337-354 is not listed on IDEAS
    14. Jarkko Jääskelä & David Jennings, 2010. "Monetary Policy and the Exchange Rate: Evaluation of VAR Models," RBA Research Discussion Papers rdp2010-07, Reserve Bank of Australia.
    15. Ivrendi, Mehmet & Yildirim, Zekeriya, 2013. "Monetary policy shocks and macroeconomic variables: Evidence from fast growing emerging economies," Economics Discussion Papers 2013-61, Kiel Institute for the World Economy (IfW).
    16. repec:bla:ausecp:v:56:y:2017:i:1:p:27-38 is not listed on IDEAS
    17. Carrillo Julio A. & Elizondo Rocío, 2015. "How Robust Are SVARs at Measuring Monetary Policy in Small Open Economies?," Working Papers 2015-18, Banco de México.

    More about this item

    Keywords

    Exchange rate; monetary policy; SVAR; Bayesian estimation; sign restrictions.;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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