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Forward guidance and the exchange rate

Jordi Galí ()

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: I analyze the effectiveness of forward guidance policies in open economies, focusing on the role played by the exchange rate in their transmission. An open economy version of the "forward guidance puzzle" is shown to emerge. In partial equilibrium, the effect on the current exchange rate of an anticipated change in the interest rate does not decline with the horizon of implementation. In general equilibrium, the size of the effect is larger the longer is that horizon. Empirical evidence using U.S. and euro area data euro-dollar points to the presence of a forward guidance exchange rate puzzle: expectations of interest rate differentials in the near (distant) future have much larger (smaller) effects on the euro-dollar exchange rate than is implied by the theory.

Keywords: forward guidance puzzle; uncovered interest rate parity; unconventional monetary policies; open economy New Keynesian model. (search for similar items in EconPapers)
JEL-codes: E43 E58 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2017-05, Revised 2018-02
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