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Risk, Monetary Policy and the Exchange Rate

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  • Gianluca Benigno
  • Pierpaolo Benigno
  • Salvatore Nisticò

Abstract

In this research, we provide new empirical evidence on the importance of time-varying uncertainty for the exchange rate and the excess return in currency markets. Following an increase in monetary policy uncertainty, the dollar exchange rate appreciates in the medium run, while an increase in the volatility of productivity leads to a dollar depreciation. We propose a general-equilibrium theory of exchange rate determination based on the interaction between monetary policy and time-varying uncertainty aimed at understanding these regularities. In the model, the behaviour of the exchange rate following nominal and real volatility shocks is consistent with the empirical evidence. Furthermore we show that risk factors and interest-rate smoothing are important in accounting for the negative coefficient in the UIP regression.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17133.

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Date of creation: Jun 2011
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Publication status: published as Gianluca Benigno & Pierpaolo Benigno & Salvatore Nistic�, 2012. "Risk, Monetary Policy, and the Exchange Rate," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 247 - 309.
Handle: RePEc:nbr:nberwo:17133
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Find related papers by JEL classification:
  • E0 - Macroeconomics and Monetary Economics - - General
  • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
  • F3 - International Economics - - International Finance
  • F31 - International Economics - - International Finance - - - Foreign Exchange
  • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Pierpaolo Benigno & Salvatore Nistic�, 2012. "International Portfolio Allocation under Model Uncertainty," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(1), pages 144-89, January.
  2. Moore, Michael J. & Roche, Maurice J., 2010. "Solving exchange rate puzzles with neither sticky prices nor trade costs," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1151-1170, October.
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  16. Gianluca Benigno & Pierpaolo Benigno & Salvatore Nisticò, 2010. "Second-Order Approximation of Dynamic Models with Time-Varying Risk," NBER Working Papers 16633, National Bureau of Economic Research, Inc.
  17. Charles Engel, 2011. "The Real Exchange Rate, Real Interest Rates, and the Risk Premium," Working Papers 272011, Hong Kong Institute for Monetary Research.
  18. Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Exchange rate determination under interest rate rules," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 971-993, October.
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  24. Lombardo, Giovanni & Sutherland, Alan, 2005. "Computing second-order-accurate solutions for rational expectation models using linear solution methods," Working Paper Series 0487, European Central Bank.
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Cited by:

  1. Caggiano, Giovanni & Castelnuovo, Efrem & Groshenny, Nicolas, 2014. "Uncertainty shocks and unemployment dynamics in U.S. recessions," Journal of Monetary Economics, Elsevier, vol. 67(C), pages 78-92.
  2. Gianluca Benigno & Pierpaolo Benigno & Salvatore Nistico, 2011. "Second-Order Approximation of Dynamic Models with Time-Varying Risk," FMG Discussion Papers dp677, Financial Markets Group.
  3. Yusuf Soner Başkaya & Timur H�lag� & Hande K���k, 2013. "Oil Price Uncertainty in a Small Open Economy," IMF Economic Review, Palgrave Macmillan, vol. 61(1), pages 168-198, April.
  4. Charles Engel, 2013. "Exchange Rates and Interest Parity," NBER Working Papers 19336, National Bureau of Economic Research, Inc.
  5. Enzo Cassino & David Oxley, 2013. "How Does the Exchange Rate Affect the Real Economy? A Literature Survey," Treasury Working Paper Series 13/26, New Zealand Treasury.
  6. Philippe Bacchetta & Eric van Wincoop, 2012. "Sudden Spikes in Global Risk," Working Papers 062012, Hong Kong Institute for Monetary Research.
  7. Martín Uribe, 2011. "Comment on "Risk, Monetary Policy and the Exchange Rate"," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 315-324 National Bureau of Economic Research, Inc.
  8. Mumtaz, Haroon & Theodoridis, Konstantinos, 2012. "The international transmission of volatility shocks: an empirical analysis," Bank of England working papers 463, Bank of England.
  9. Bijapur, Mohan, 2014. "What Drives Business Cycle Fluctuations: Aggregate or Idiosyncratic Uncertainty Shocks?," MPRA Paper 60361, University Library of Munich, Germany.

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