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Exchange Rate Policy after a Decade of "Floating"

In: Exchange Rate Theory and Practice

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  • William H. Branson
Abstract
This paper integrates exchange-rate policy into a model of exchange- rate behavior, and examines the data econometrically to infer hypotheses about policy behavior in the 1970s. The model shows how unanticipated movements in money, the current account, and relative price levels will cause first a jump in the exchange rate, and then a movement along a "saddle path" to the new long run equilibrium. Here the role of "news" in moving the exchange rate is clear. The model is used to analyze the options available to the central bank that wants to reduce the jump in the exchange rate following a real or monetary disturbance. The distinction is made between monetary policy and sterilized intervention, and a regime in which the domestic interest rate is used as the policy variable is also studied. Systems of vector autoregressions (VARs) for each of four countries -- the U.S., the U.K., Germany, and Japan -- are estimated, and the correlations among their residuals are studied. These represent the "innovations," or "news" in the time series. A clear pattern emerges in these correlations, in which policy in the U.S. and to a lesser extent Japan, drives exchange rates, and policy in Germany and the U.K. reacts. It appears that U.S. monetary policy is essentially determined by domestic considerations, with the exchange rate moving as a consequence. In Japan, interest rates are varied in response to movement in the current-account and relative price levels, and the effects on the exchange rate are partially neutralized by sterilized intervention. Germany and the U.K. react to movements in their exchange rates by moving interest rates, and sterilized intervention.
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Suggested Citation

  • William H. Branson, 1984. "Exchange Rate Policy after a Decade of "Floating"," NBER Chapters, in: Exchange Rate Theory and Practice, pages 79-118, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:6830
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    References listed on IDEAS

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    Cited by:

    1. Awad, Taleb Mohammad, 1987. "International monetary and exchange rate policies and world agricultural markets: the case of soybeans and soybean products," ISU General Staff Papers 198701010800009611, Iowa State University, Department of Economics.
    2. Dibooglu, Selahattin, 1993. "Multiple cointegration and structural models: applications to exchange rate determination," ISU General Staff Papers 1993010108000011419, Iowa State University, Department of Economics.
    3. Amir D. Aczel & Norman H. Josephy, 1991. "The Chaotic Behavior of Foreign Exchange Rates," The American Economist, Sage Publications, vol. 35(2), pages 16-24, October.
    4. William H. Branson & Jacob A. Frenkel, 1985. "Causes of Appreciation and Volatility of the Dollar with Comment by Jacob Frenkel," NBER Working Papers 1777, National Bureau of Economic Research, Inc.
    5. William H. Branson, 1985. "The Dynamic Interaction of Exchange Rates and Trade Flows," NBER Working Papers 1780, National Bureau of Economic Research, Inc.
    6. O. P. C. Muhammed Rafi & M. Ramachandran, 2018. "Capital flows and exchange rate volatility: experience of emerging economies," Indian Economic Review, Springer, vol. 53(1), pages 183-205, December.
    7. Warwick McKibbin & Jeffrey D. Sachs, 1988. "Coordination of Monetary and Fiscal Policies in the Industrial Economies," NBER Chapters, in: International Aspects of Fiscal Policies, pages 73-120, National Bureau of Economic Research, Inc.
    8. Kumah, Francis Y. & Ibrahim, Saifu B., 1996. "Stochastic trends and fluctuations in the interest rate, exchange rate and the current account balance: An empirical investigation," Economic Modelling, Elsevier, vol. 13(3), pages 383-406, July.

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