On the empirical relevance of the exchange rate as a shock absorber at the zero lower bound

David Finck, Mathias Hoffmann and Patrick Hürtgen

No 10/2023, Discussion Papers from Deutsche Bundesbank

Abstract: We estimate the effects of a negative asymmetric demand shock on the real exchange rate for the euro area vis-à-vis the United States, Canada, and Japan by state-dependent sign-restricted local projection methods. We find a real depreciation when interest rates are not at the ZLB, but also when they are. The exchange rate can accomodate considerable variations in output, confirming its shock-absorbing capacity before and during the ZLB episode. The stabilizing role of the exchange rate is accompanied by a significant expansion of the ECB's balance sheet at the ZLB, while it remained unaffected in the pre-ZLB period. Our empirical results can be reconciled with an open economy New Keynesian model extended with unconventional monetary policy measures when interest rates are at the ZLB.

Keywords: Zero Lower Bound; Exchange Rate; Local Projections; State-dependent Effects; Unconventional Monetary Policy; Demand Shocks (search for similar items in EconPapers)
JEL-codes: C54 E31 E37 F31 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:102023

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