Monetary Policy Responses to the Exchange Rate: Empirical Evidence from the ECB
Birkbeck, University of London - Department of Economics; Bilkent University - Department of Economics
December 18, 2013
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.
Number of Pages in PDF File: 19
Keywords: Monetary Policy, Exchange Rates, Identi cation through Heteroscedasticity, European Central Bank, Monetary Policy Reaction
JEL Classification: E44, E52, G12
Date posted: February 18, 2012 ; Last revised: May 28, 2014