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The Open Economy Consequences of U.S. Monetary Policy

  • John C. Bluedorn
  • Christopher Bowdler

A failure to identify movements in the federal funds rate that are both unpredictable and independent of other determinants of open economy variables may lead to attenuation bias in the estimated effects of U.S. monetary policy on the exchange rate and foreign variables. Using a U.S. monetary policy measure which isolates unpredictable and independent federal funds rate changes, we quantify the magnitude of the attenuation bias for the exchange rate and foreign variables. The exchange rate appreciation following a monetary contraction is up to 4 times larger than a recursively-identified VAR estimate. There is stronger evidence of foreign interest rate pass-through. The expenditure-reducing effects of a U.S. monetary policy contraction dominate any expenditure-switching effects, leading to a positive conditional correlation of international outputs and prices. We compare our results with those obtained using identification based upon: (1) non-recursive VAR restrictions; and, (2) restrictions derived from high frequency asset price behavior.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 265.

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Date of creation: 01 Jun 2006
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Handle: RePEc:oxf:wpaper:265
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