Interest Rates, Convenience Yields, and Inflation Expectations: Drivers of US Dollar Exchange Rates

Kerstin Bernoth (), Helmut Herwartz and Lasse Trienens

No 2100, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: Using a data-driven approach to identify structural vector autoregressive models, we examine key factors influencing the US dollar exchange rate across eight advanced economies from 1980 to 2022. We find that shocks to inflation expectations, which are closely tied to unfunded government transfer payments, have a pronounced effect on the US dollar’s value. This underscores the fiscal dimension of exchange rates. External shocks, related to the convenience yield investors forgo to hold US dollar assets, have emerged over time as the most powerful driver of US dollar exchange rate fluctuations. These findings provide new insights into the complex interplay of monetary policy, fiscal dynamics, and global market forces in shaping US dollar exchange rates.

Keywords: Exchange rates; convenience yield; inflation expectations; monetary policy; fiscal policy; unfunded government transfer payment; monetary-fiscal policy mix (search for similar items in EconPapers)
JEL-codes: C32 E43 E52 F31 F41 G15 (search for similar items in EconPapers)
Pages: 48 p.
Date: 2024
New Economics Papers: this item is included in nep-ban, nep-mon and nep-opm
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https://www.diw.de/documents/publikationen/73/diw_01.c.927006.de/dp2100.pdf (application/pdf)

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Working Paper: Interest Rates, Convenience Yields and Inflation Expectations: Drivers of US Dollar Exchange Rates (2024)
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