Does a big bazooka matter? Central bank balance-sheet policies and exchange rates

Luca Dedola, Georgios Georgiadis, Johannes Gräb () and Arnaud Mehl

No 2197, Working Paper Series from European Central Bank

Abstract: We estimate the effects of quantitative easing (QE) measures by the ECB and the Federal Reserve on the US dollar-euro exchange rate at frequencies and horizons relevant for policymakers. To do so, we derive a theoretically-consistent local projection regression equation from the standard asset pricing formulation of exchange rate determination. We then proxy unobserved QE shocks by future changes in the relative size of central banks’ balance sheets, which we instrument with QE announcements in two-stage least squares regressions in order to account for their endogeneity. We find that QE measures have large and persistent effects on the exchange rate. For example, our estimates imply that the ECB’s APP program which raised the ECB’s balance sheet relative to that of the Federal Reserve by 35 percentage points between September 2014 and the end of 2016 depreciated the euro vis-à-vis the US dollar by a 12%. Regarding transmission channels, we find that a relative QE shock that expands the ECB’s balance sheet relative to that of the Federal Reserve depreciates the US dollar-euro exchange rate by reducing euro-dollar short-term money market rate differentials, by widening the cross-currency basis and by eliciting adjustments in currency risk premia. Changes in the expectations about the future monetary policy stance, reflecting the “signalling” channel of QE, also contribute to the exchange rate response to QE shocks. JEL Classification: E5, F3

Keywords: CIP deviations; interest rate parity condition; quantitiative easing (search for similar items in EconPapers)
Date: 2018-11
New Economics Papers: this item is included in nep-mon and nep-opm
Note: 80922
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2197.en.pdf (application/pdf)

Related works:
Working Paper: Does a Big Bazooka Matter? Central Bank Balance-Sheet Policies and Exchange Rates (2018)
Working Paper: Does a Big Bazooka Matter? Central Bank Balance-Sheet Policies and Exchange Rates (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20182197

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank 60640 Frankfurt am Main, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Official Publications ().