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Money's causal role in exchange rate: Do divisia monetary aggregates explain more?

Taniya Ghosh () and Soumya Bhadury

International Review of Economics & Finance, 2018, vol. 57, issue C, 402-417

Abstract: We investigate the power of Divisia monetary aggregates in predicting exchange rate variations for India, Israel, Poland, the UK, and the US in the years leading up to and following the 2007–08 recession, during which the interest rates for some major economies have been stuck at or near the zero lower bound (ZLB). Consequently, the interest rate has become uninformative regarding the stance of monetary policies. As an important innovation, our research adopts the Divisia monetary aggregate as an alternative to the policy indicator variable. We apply the bootstrap Granger causality method, which is robust to the presence of non-stationarity in our data. We also apply bootstrap rolling window estimates to account for the parameter non-constancy and structural breaks in our sample. We find a strong causality from Divisia money to exchange rates and further highlight the importance of Divisia at ZLB by capturing the time-varying link between these variables.

Keywords: Monetary policy; Divisia monetary aggregates; Simple sum; Nominal exchange rate; Real effective exchange rate; Bootstrap granger causality (search for similar items in EconPapers)
JEL-codes: C32 C43 E41 E51 E52 F31 F41 (search for similar items in EconPapers)
Date: 2018
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Working Paper: Money's Causal Role in Exchange Rate: Do Divisia Monetary Aggregates Explain More? (2018) Downloads
Working Paper: Money's Causal Role in Exchange Rate: Do Divisia Monetary Aggregates Explain More? (2017) Downloads
Working Paper: Money's causal role in exchange rate: Do Divisia monetary aggregates explain more? (2017) Downloads
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