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Monetary Policy Responses to the Exchange Rate: Empirical Evidence from the ECB

19 Pages Posted: 18 Feb 2012 Last revised: 28 May 2014

Ishak Demir

Birkbeck, University of London - Department of Economics; Bilkent University - Department of Economics

Date Written: December 18, 2013

Abstract

The exchange rate is an important part of the transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. It can be difficult to measure the reaction of monetary policy to the movements of the exchange rate, due to the simultaneous response of monetary policy to the exchange rate and the possibility that both variables respond to several other variables. This study addresses these problems by using an identification method based on the heteroscedasticity in the high-frequency data. The results in this paper suggest that the ECB systematically responds to exchange rate movements but that quantitative effects are small. Such a significant but small reaction coefficient seems consistent with the hypothesis that the central banks do not target the fluctuations in the exchange rate but consider them only to the extent they impact on the expected inflation and output path.

Keywords: Monetary Policy, Exchange Rates, IdentiĀ…cation through Heteroscedasticity, European Central Bank, Monetary Policy Reaction

JEL Classification: E44, E52, G12

Suggested Citation

Demir, Ishak, Monetary Policy Responses to the Exchange Rate: Empirical Evidence from the ECB (December 18, 2013). Available at SSRN: https://ssrn.com/abstract=2007344 or http://dx.doi.org/10.2139/ssrn.2007344

Ishak Demir (Contact Author)

Birkbeck, University of London - Department of Economics ( email )

Malet Street
London, WC1E 7HX
United Kingdom

Bilkent University - Department of Economics ( email )

Bilkent University, Department of
Economics
Bilkent, Ankara 06800
Turkey

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