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New Evidence on the Puzzles: Monetary Policy and Exchange Rates

Author

Listed:
  • Almuth Scholl
  • Harald Uhlig

Abstract

Past empirical research on monetary policy in open economies has found the “delayed overshooting†, the “forward discount†and the “exchange rate†puzzles. We revisit the effects of monetary policy on exchange rates by applying Uhlig's (2005) identification procedure that involves sign restrictions on the impulse responses of selected variables. We impose no restrictions on the exchange rate to leave the key question as open as possible. Importantly, our identification scheme avoids the “price puzzle†. We find that the puzzles regarding the exchange rate are still there, but that the quantitative features are different. In response to US monetary policy shocks, the peak appreciation happens during the first year after the shock for the US-UK and the US-Japan country pair and during the first two years for the US-Germany country pair. There is a robust forward discount puzzle implying a large risk premium. We study this issue by calculating conditional Sharpe ratios for a Bayesian investor investing in a hedged position following a US monetary policy shock. For foreign monetary policy shocks, we find a considerable uncertainty regarding the initial reaction of the exchange rate. Quantitatively, monetary policy shocks seem to have a minor impact on exchange rate fluctuations

Suggested Citation

  • Almuth Scholl & Harald Uhlig, 2006. "New Evidence on the Puzzles: Monetary Policy and Exchange Rates," Computing in Economics and Finance 2006 5, Society for Computational Economics.
  • Handle: RePEc:sce:scecfa:5
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    File URL: http://repec.org/sce2006/up.6904.1134637537.pdf
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    Cited by:

    1. Jean Boivin & Marc P. Giannoni & Benoît Mojon, 2008. "How Has the Euro Changed the Monetary Transmission?," NBER Working Papers 14190, National Bureau of Economic Research, Inc.
    2. Jean Boivin & Marc P. Giannoni, 2007. "Global Forces and Monetary Policy Effectiveness," NBER Chapters,in: International Dimensions of Monetary Policy, pages 429-478 National Bureau of Economic Research, Inc.
    3. Haroon Mumtaz & Konstantinos Theodoridis, 2015. "The International Transmission Of Volatility Shocks: An Empirical Analysis," Journal of the European Economic Association, European Economic Association, vol. 13(3), pages 512-533, June.
    4. Schenkelberg, Heike & Watzka, Sebastian, 2013. "Real effects of quantitative easing at the zero lower bound: Structural VAR-based evidence from Japan," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 327-357.
    5. Jean Boivin & Marc P. Giannoni & Benoît Mojon, 2009. "How Has the Euro Changed the Monetary Transmission Mechanism?," NBER Chapters,in: NBER Macroeconomics Annual 2008, Volume 23, pages 77-125 National Bureau of Economic Research, Inc.
    6. Mumtaz, Haroon, 2011. "Estimating the impact of the volatility of shocks: a structural VAR approach," Bank of England working papers 437, Bank of England.

    More about this item

    Keywords

    vector autoregressions; agnostic identification; forward discount bias puzzle; exchange rate puzzle; monetary policy;

    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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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