Forward guidance and the exchange rate: A theoretical sign restricted VAR analysis

This paper uses zero and signs restrictions to study the effect of the U.S. forward guidance and unanticipated monetary policy on four U.S. bilateral nominal exchange rates and net exports. I find that although the U.S. forward guidance easing depreciates the exchange rate, the policy does not transmit to the real activity via an “expenditure-switching effect” on the net exports. The use of narrative sign restrictions improves the identification method. The complementary results are as follows: a VAR model augmented with interest rate forecasts contains at least enough information to identify the forward guidance and unanticipated monetary shocks; the nominal bilateral exchange rates depreciate by two to four percent after a 25 basis point forward guidance easing in a hump-shaped pattern without any deviation from the Uncovered Interest rate Parity condition; both shocks explain between 7.3 percent to 27.9 percent of the exchange rates variance, and the forward guidance shock contributes to at least half of this variance decomposition; finally, forecasters perceive the forward guidance shock as future deviation from the Taylor rule.