Monetary Policy's Role in Exchange Rate Behavior

33 Pages Posted: 6 Nov 2000

See all articles by Jon Faust

Jon Faust

Board of Governors of the Federal Reserve - Division of International Finance; Johns Hopkins University

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section

Date Written: November 1999

Abstract

While much empirical work has addressed the role of monetary policy shocks in exchange rate behavior, conclusions have been clouded by the lack of plausible identifying assumptions. We apply a recently developed inference procedure allowing us to relax dubious identifying assumptions. This work overturns some earlier results and strengthens others: i) Contrary to earlier findings of "delayed overshooting," the peak exchange rate effect of policy shocks may come nearly immediately after the shock; ii) In every otherwise reasonable identification, monetary policy shocks lead to large uncovered interest rate parity (UIP) deviations; iii) Monetary policy shocks may account for a smaller portion of the variance of exchange rates than found in earlier estimates. While (i) is consistent with overshooting, (ii) implies that the overshooting cannot be driven by ornbusch's mechanism, and (iii) gives reason to doubt whether monetary policy shocks are the main source of exchange rate volatility. monetary policy, identification

Keywords: exchange rates, overshooting, forward premium bias,

JEL Classification: E4, F3, F4

Suggested Citation

Faust, Jon and Rogers, John H., Monetary Policy's Role in Exchange Rate Behavior (November 1999). International Finance Working Paper No. 652. Available at SSRN: https://ssrn.com/abstract=231828 or http://dx.doi.org/10.2139/ssrn.231828

Jon Faust (Contact Author)

Board of Governors of the Federal Reserve - Division of International Finance ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2328 (Phone)
202-736-5638 (Fax)

Johns Hopkins University

Baltimore, MD 20036-1984
United States

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2873 (Phone)
202-736-5638 (Fax)

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