Measuring the Effects of US Unconventional Monetary Policy Surprises on Exchange Rates across Monetary Conditions

This paper examines the responses of foreign exchange rates to the Federal Reserve’s large-scale asset purchases (LSAP) and forward guidance (FWG) from 2009 to 2022. I confirm heterogeneous responses of examined foreign exchange rates to unconventional shocks, varying by magnitude and duration depending on the type of shock and monetary policy condition. Both shocks led to an appreciation of foreign currencies against the US dollar across all monetary policy regimes, except for the forward guidance (FWG) shock during the monetary policy normalization period, for which no statistically significant effect was observed. Over the course of the response horizon, the FWG shock had a greater impact magnitude on the examined foreign exchange rates than the LSAP shock. The effects of both unconventional shocks were more persistent during periods of zero lower bound (ZLB) on the policy interest rate than during normalization periods of monetary policy. However, the impact of such shocks on foreign exchange rates diminished within a couple of months, contrasting with the literature that finds more persistent effects. The implementation of variance decomposition reveals that the FWG shock had a significantly greater influence on foreign exchange rate variation than the LSAP shock, emphasizing the importance of effective guidance communication to the markets.