Fluctuations in the Foreign Exchange Market: How Important are Monetary Policy Shocks?

Cahier de recherche Working Paper No. 08-18

39 Pages Posted: 18 Sep 2008

See all articles by Hafedh Bouakez

Hafedh Bouakez

HEC Montréal

Michel Normandin

HEC Montreal - Institute of Applied Economics

Date Written: September, 16 2008

Abstract

We study the effects of U.S. monetary policy shocks on the bilateral exchange rate between the U.S. and each of the G7 countries. We also estimate deviations from uncovered interest rate parity and exchange rate pass-through conditional on these shocks. The analysis is based on a structural vector autoregression in which monetary policy shocks are identified through the conditional heteroscedasticity of the structural disturbances. Unlike earlier work in this area, our empirical methodology avoids making arbitrary assumptions about the relevant policy indicator or transmission mechanism in order to achieve identification. At the same time, it allows us to assess the implications of imposing invalid identifying restrictions. Our results indicate that the nominal exchange rate exhibits delayed overshooting in response to a monetary expansion, depreciating for roughly ten months before starting to appreciate. The shock also leads to large and persistent departures from uncovered interest rate parity, and to a prolonged period of incomplete pass-through. Variance-decomposition results indicate that monetary policy shocks account for a non-trivial proportion of exchange rate fluctuations.

Keywords: Conditional heteroscedasticity, delayed overshooting, exchange rate pass-through, identification, structural vector autoregression, uncovered interest rate parity

JEL Classification: C32, E52, F31, F41

Suggested Citation

Bouakez, Hafedh and Normandin, Michel, Fluctuations in the Foreign Exchange Market: How Important are Monetary Policy Shocks? (September, 16 2008). Cahier de recherche Working Paper No. 08-18, Available at SSRN: https://ssrn.com/abstract=1268988 or http://dx.doi.org/10.2139/ssrn.1268988

Hafedh Bouakez (Contact Author)

HEC Montréal ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada
1-514-340-7003 (Phone)
1-514-340-6469 (Fax)

Michel Normandin

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
69
Abstract Views
596
rank
364,788
PlumX Metrics