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The effects of conventional and unconventional monetary policy on exchange rates

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Abstract
What are the effects of monetary policy on exchange rates? And have unconventional monetary policies changed the way monetary policy is transmitted to international financial markets? According to conventional wisdom, expansionary monetary policy shocks in a country lead to that country's currency depreciation. We revisit the conventional wisdom during both conventional and unconventional monetary policy shocks as changes int he whole yield curve due to unanticipated monetary policy moves and allows monetary policy shocks to differ depending on how they affect agents' expectations about the future path of interest rates as well as their perceived effects on the riskiness/uncertainty in the economy. Our empirical results show that: (i) a monetary policy easing leads to a depreciation of the country's spot nominal exchange rate in both conventional and unconventional periods; (ii) however, there is substancial heterogeneity in monetary policy shocks over time and their effects depend on the way they affect agents'expectations; (iii) we find favorable evidence to Dornbusch's (1976) overshooting hypothesis; (iv) changes in expected real interest rates play an important role in the transmission of monetary policy shocks.

Suggested Citation

  • Atsushi Inoue & Barbara Rossi, 2018. "The effects of conventional and unconventional monetary policy on exchange rates," Economics Working Papers 1639, Department of Economics and Business, Universitat Pompeu Fabra.
    • Handle: RePEc:upf:upfgen:1639
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    More about this item

    Keywords

    Exchange rates; Zero-lower bound; unconventional monetary policy; forward guidance.;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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