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Monetary Policy and Exchange Rate Response: Evidence from Shock-based SVAR with Uncertainty Measures

Cheolbeom Park and Seungyoo Shin ()
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Seungyoo Shin: Department of Economics, Boston University, Boston, Massachusetts, US

No 2102, Discussion Paper Series from Institute of Economic Research, Korea University

Abstract: We examine the response of the exchange rate to monetary policy shocks using structural vector autoregression (SVAR). The SVAR approach employed in this study differs from the approaches used in previous studies in that we add uncertainty measures and employ shock-based identification constraints. Using structural shocks that are in accordance with the event and external variable constraints, we demonstrate that the US real effective exchange rate appreciates immediately in response to contractionary monetary policy shocks, with the maximum appreciation occurring within 1 to 2 quarters. We also provide evidence that recursive identification restrictions or the exclusion of any one of the two types of uncertainty measure can generate anomalous responses by the exchange rate. We further show via variance decomposition that monetary policy shocks explain a substantial portion of exchange rate variability, although they are not the most dominant driving force behind this variability.

Keywords: Exchange rate; Monetary policy; Structural vector autoregressive; Uncovered interest rate parity (search for similar items in EconPapers)
JEL-codes: C32 E52 F31 F41 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon, nep-opm and nep-ore
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