Determinants of the Movements in the Euro-Dollar Exchange Rate During the Sovereign Debt Crisis

21 Pages Posted: 8 Apr 2016

Date Written: January 21, 2016

Abstract

We identify the drivers of the movements in the euro-dollar exchange rate during the sovereign debt crisis. In particular, we show that the announcement of outright monetary transactions (OMT) by the Governing Council of the ECB during the summer of 2012 played a major role in the euro’s subsequent appreciation. OMT and the reform efforts undertaken by governments at national and European level saw off the risk of a euro-area break up and prompted net capital inflows. We estimate two models. The first is a reduced form high-frequency model, in which the exchange rate is explained by the differentials between interest rates in euros and dollars at both short- and long-term horizons, the sovereign spread in euro-area countries and an index of volatility. The second is a vector autoregressive (VAR) model including GDP growth differentials, short-term nominal interest rate differentials and inflation differentials between the euro area and the U.S., an average of the sovereign spreads of selected euro-area countries, the bilateral trade balance and the euro-dollar nominal exchange rate. Both approaches suggest that the evolution of the sovereign spread supported the value of the euro following the announcement of OMT in the summer of 2012.

Keywords: exchange rates, sovereign spreads, vector autoregression

JEL Classification: F31, C32

Suggested Citation

Anzuini, Alessio and Cecioni, Martina and Neri, Stefano, Determinants of the Movements in the Euro-Dollar Exchange Rate During the Sovereign Debt Crisis (January 21, 2016). Bank of Italy Occasional Paper No. 305. Available at SSRN: https://ssrn.com/abstract=2759823 or http://dx.doi.org/10.2139/ssrn.2759823

Alessio Anzuini (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Martina Cecioni

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Stefano Neri

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy
+39 06 4792 2821 (Phone)

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