IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Liquidity and Exchange Rates: Puzzling Evidence from the G-7 Countries

Listed author(s):
  • Vittorio Grilli
  • Nouriel Roubini

This paper considers the empirical evidence on liquidity effects in open economies; we study the effects of monetary policy shocks (identified by innovations in interest rates) on exchange rates. Both overshooting models with short-run price stickiness and flexible-price models with "liquidity effects" suggest that, in the short-run, the effects of a positive monetary innovation will be a reduction of nominal interest rates and a depreciation of the domestic currency. We consider VAR systems for the G-7 countries and find that, while positive innovations in U.S. interest rates lead to an impact appreciation of the U.S. dollar, positive innovations in the interest rates of the other G-7 countries are associated with an impact depreciation of their currency. We offer two explanations of this "exchange rate puzzle"; one is based on the idea that the U.S. is the "leader" country in the setting of monetary policy for the G-7 area, while the other countries are "follow! ers". The other explanation suggests endogenous policy reaction to underlying inflationary shocks that are a cause of exchange rate depreciation. We then offer some empirical evidence consistent with these two interpretations of the exchange rate puzzle: after controlling for U.S. monetary policies and expected inflation, the response of exchange rates to postive interest rate shocks is a persistent currency appreciation in most of the G-7 countries. Moreover, consistently with both overshooting and liquidity models, a monetary contraction is associated with a transitory appreciation of the real exchange rate and a temporary fall in output.

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 95-17.

in new window

Date of creation: Oct 1995
Handle: RePEc:ste:nystbu:95-17
Contact details of provider: Postal:
New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126

Phone: (212) 998-0860
Fax: (212) 995-4218
Web page:

More information through EDIRC

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:ste:nystbu:95-17. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Viveca Licata)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.