Fluctuations in the Foreign Exchange Market: How Important are Monetary Policy Shocks?

Hafedh Bouakez and Michel Normandin ()

Cahiers de recherche from CIRPEE

Abstract: We study the effects of U.S. monetary policy shocks on the bilateral exchange rate between the U.S. and each of the G7 countries. We also estimate deviations from uncovered interest rate parity and exchange rate pass-through conditional on these shocks. The analysis is based on a structural vector autoregression in which monetary policy shocks are identified through the conditional heteroscedasticity of the structural disturbances. Unlike earlier work in this area, our empirical methodology avoids making arbitrary assumptions about the relevant policy indicator or transmission mechanism in order to achieve identification. At the same time, it allows us to assess the implications of imposing invalid identifying restrictions. Our results indicate that the nominal exchange rate exhibits delayed overshooting in response to a monetary expansion, depreciating for roughly ten months before starting to appreciate. The shock also leads to large and persistent departures from uncovered interest rate parity, and to a prolonged period of incomplete pass-through. Variance-decomposition results indicate that monetary policy shocks account for a non-trivial proportion of exchange rate fluctuations.

Keywords: Conditions heteroscedasticity; delayed overshooting; exchange rate pass-through; identification; structural vector autoregression; uncovered interest rate parity (search for similar items in EconPapers)
JEL-codes: C32 E52 F31 F41 (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Journal Article: Fluctuations in the foreign exchange market: How important are monetary policy shocks? (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:0818

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