The Impact of Monetary Policy on the Exchange Rate: Evidence from Three Small Open Economies

Abstract

This paper studies the impact effect of monetary policy shocks - identified by the reaction of three month market interest rates to policy announcements - on the exchange rate in Australia, Canada, and New Zealand during the 1990s. The main results are that (i) on average, a 100 basis point contractionary shock will appreciate the exchange rate by 2-3 percent on impact; (ii) seemingly perverse reactions of the exchange rate to monetary policy are mainly attributable to reverse causality; (iii) in a few instances, there were true perverse reactions of exchange rates to policy - generally, appreciations following expansionary shocks.

Keywords: Monetary Policy, Interest Rates, Exchange Rates

JEL Classification: E52, E58, F31, F41