Monetary Policy and the Predictability of Nominal Exchange Rates

52 Pages Posted: 13 Feb 2017

See all articles by Martin Eichenbaum

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Benjamin Kramer Johannsen

Board of Governors of the Federal Reserve System

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2017

Abstract

This paper studies how the monetary policy regime affects the relative importance of nominal exchange rates and inflation rates in shaping the response of real exchange rates to shocks. We document two facts about inflation-targeting countries. First, the current real exchange rate predicts future changes in the nominal exchange rate. Second, the real exchange rate is a poor predictor of future inflation rates. We estimate a medium-size DSGE open-economy model that accounts quantitatively for these facts as well as other empirical properties of real and nominal exchange rates. The key estimated shocks that accounts for the dynamics of exchange rates and their covariance with inflation are disturbances to the foreign demand for dollar-denominated bonds.

Suggested Citation

Eichenbaum, Martin and Johannsen, Benjamin Kramer and Tavares Rebelo, Sergio, Monetary Policy and the Predictability of Nominal Exchange Rates (February 2017). NBER Working Paper No. w23158. Available at SSRN: https://ssrn.com/abstract=2915985

Martin Eichenbaum (Contact Author)

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Benjamin Kramer Johannsen

Board of Governors of the Federal Reserve System ( email )

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Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

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