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

  • Hilde C. Bjørnland

    ()

  • Jørn I. Halvorsen

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.

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File URL: http://www.bi.edu/InstitutterFiles/Samfunns%c2%b0konomi/CAMAR_wp_0110.pdf
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Paper provided by Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School in its series Working Papers with number 0001.

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Length: 49 pages
Date of creation: Nov 2010
Date of revision:
Handle: RePEc:bny:wpaper:0001
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Web page: http://www.bi.no/camp/
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  1. 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.
  2. Farrant, Katie & Peersman, Gert, 2006. "Is the Exchange Rate a Shock Absorber or a Source of Shocks? New Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 939-961, June.
  3. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  4. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, 2004. "Inflation Dynamics And The Cost Channel Of Monetary Transmission," Royal Economic Society Annual Conference 2004 80, Royal Economic Society.
  5. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  6. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  7. Wei Dong, 2008. "Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation," Working Papers 08-24, Bank of Canada.
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