The Exchange Rate Response Puzzle

49 Pages Posted: 1 Feb 2012 Last revised: 7 Aug 2012

See all articles by Viktoria V. Hnatkovska

Viktoria V. Hnatkovska

University of British Columbia (UBC) - Department of Economics

Amartya Lahiri

University of British Columbia (UBC) - Department of Economics

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Date Written: May 31, 2012

Abstract

We present a new data fact: in response to a monetary tightening, the nominal exchange tends to appreciate in developed countries but depreciate in developing countries. A model is formalized to rationalize this puzzling pattern. It has three key channels of monetary transmission: a liquidity demand channel, a fiscal channel and an output channel. These have offsetting effects on the exchange rate. The paper shows that a calibrated version of the model can explain the contrast between developed and developing countries. Using counterfactual experiments we identify differences in the liquidity demand effect as being key to the contrasting responses generated by the model. Finally, the paper provides independent evidence of systematic variation between appreciating and depreciating countries in the strength of the liquidity demand effect.

Keywords: Monetary policy, interest rates, exchange rates

JEL Classification: F3, F4

Suggested Citation

Hnatkovska, Viktoria V. and Lahiri, Amartya and Vegh, Carlos A., The Exchange Rate Response Puzzle (May 31, 2012). Available at SSRN: https://ssrn.com/abstract=1996693 or http://dx.doi.org/10.2139/ssrn.1996693

Viktoria V. Hnatkovska (Contact Author)

University of British Columbia (UBC) - Department of Economics ( email )

997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada

HOME PAGE: http://faculty.arts.ubc.ca/vhnatkovska/

Amartya Lahiri

University of British Columbia (UBC) - Department of Economics ( email )

997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada
604.822.8606 (Phone)

HOME PAGE: http://www.econ.ubc.ca/alahiri/

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

University of California at Los Angeles ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-825-7371 (Phone)
310-825-9528 (Fax)

HOME PAGE: http://vegh.sscnet.ucla.edu

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
97
Abstract Views
647
rank
294,315
PlumX Metrics