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Monetary Policy and Exchange Rate Response: Evidence from Shock-based SVAR with Uncertainty Measures

Author

Listed:
  • Cheolbeom Park

    (Department of Economics, Korea University, Seoul, Republic of Korea)

  • Seungyoo Shin

    (Department of Economics, Boston University, Boston, Massachusetts, US)

Abstract

We examine the response of the exchange rate to monetary policy shocks using structural vector autoregression (SVAR). The SVAR approach employed in this study differs from the approaches used in previous studies in that we add uncertainty measures and employ shock-based identification constraints. Using structural shocks that are in accordance with the event and external variable constraints, we demonstrate that the US real effective exchange rate appreciates immediately in response to contractionary monetary policy shocks, with the maximum appreciation occurring within 1 to 2 quarters. We also provide evidence that recursive identification restrictions or the exclusion of any one of the two types of uncertainty measure can generate anomalous responses by the exchange rate. We further show via variance decomposition that monetary policy shocks explain a substantial portion of exchange rate variability, although they are not the most dominant driving force behind this variability.

Suggested Citation

  • Cheolbeom Park & Seungyoo Shin, 2021. "Monetary Policy and Exchange Rate Response: Evidence from Shock-based SVAR with Uncertainty Measures," Discussion Paper Series 2102, Institute of Economic Research, Korea University.
    • Handle: RePEc:iek:wpaper:2102
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    File URL: http://econ.korea.ac.kr/~ri/WorkingPapers/w2102.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Exchange rate; Monetary policy; Structural vector autoregressive; Uncovered interest rate parity;
    All these keywords.

    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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