The asymmetric information hypothesis argues that reduced transactions costs due to the emu should increase the share of european portfolio investment within the currency area. Under uncertainty, the relative stability of the various curves deter. The impact of monetary policies on exchange rate is important because the exchange rate is known as a channel in the direction of monetary shocks on the real sector of the economy. The impact of monetary policy on the exchange rate.
Abstract we document that a trading strategy that is short the u. Exchange rates and monetary policy uncertainty 2016 this item may be available elsewhere in econpapers. Pdf exchange rate uncertainty and monetary transmission. These findings indicate that the link between the interest rate and the exchange rate is highly unpredictable, leading up to uncertainty in the conduct of monetary policy.
Mueller, philippe and tahbazsalehi, alireza and vedolin, andrea, exchange rates and monetary policy uncertainty june 20, 2016. Exchange rates during the crisis sebastian weber charles wyplosz keywords. Exchange rates and monetary policy uncertainty 2017 working paper. Monetary policy, model uncertainty and exchange rate volatility abstract this paper proposes an explanation of the shifts in the volatility of exchange rate returns that relies on standard present value exchange rate models. Increased stock of money or through credit markets could be uncertainty about key parameters in the model, such missing from models in which monetary policy works as the response of output to interest rates and the entirely through its effect on interest rates and response of inflation to the output gap, should typi exchange rates. We show that these excess returns i are higher for currencies with higher interest rate differentials vis.
Exchange rates and monetary policy uncertainty article in the journal of finance 723 february 2017 with 53 reads how we measure reads. In other related work, bekaert, hoerova, and lo duca 20 examine the e ects of conventional monetary policy on risk aversion and uncertainty using a fourvariable structural. Market interest rates incorporate a risk premium, but the change in the market interest rate is a good proxy for the policy surprise, as the risk premium is unlikely to move in the short time periods used in the event. In doing so, it takes some of the burden off conventional monetary policy conducted through interest rates and adds a degree of freedom for monetary policy. The primary objective of monetary policy in south africa is to achieve and maintain price stability in the interest of sustainable and balanced economic development and growth. Exchange rates and monetary policy uncertainty ideasrepec. Pierpaolo benigno, new york university andrew rose, university of california, berkeley. Exchange rates and monetary policy uncertainty systemic risk. Monetary policy uncertainty stanford institute for theoretical. Impact of monetary policy uncertainty on asian exchange rates. The text examines interest rates and financial regulations, the history and objectives of monetary policies and the effects of monetary changes on employment and inflation. The relationship between exchange rate policy and monetary. We propose a theory of exchange rate determination based on exogenous risk factors in which the link between risk and the nominal exchange rate is guided by monetary policy through interest rate rules. Measuring monetary policy uncertainty and estimating its transmission effects are the focus of this paper.
Using exchange rates as monetary policy instruments. This paper assesses the impact of economic policy uncertainty to uk monetary policy stance and exchange rate movements in light of the uks decision to leave the european union. Mueller, philippe, tahbazsalehi, alireza and vedolin, andrea 2016 exchange rates and monetary policy uncertainty. The analysis reveals that monetary policy uncertainty in the united states tends to increase the variance of exchange rates in some asian countries, but has no systematic effect on exchange rate levels. Exchange rates and monetary policy uncertainty philippe muellery alireza tahbazsalehiz andrea vedolinx december 2015 abstract we document that a trading strategy that is short the u. When the euro was created almost two decades ago, there was considerable uncertainty about. Ultimately, under a fixed exchange rate system, monetary policy is delegated to the central bank of the country to whose currency ones own is pegged. We evaluate the usefulness of our mpu indexes, and examine the influence of fed communication. Exchange rates and monetary policy uncertainty ssrn. Impact of monetary policy uncertainty on asian exchange rates key points this policy brief examines the impact of monetary policy uncertainty in the united states on asian exchange rates. Monetary policy and economic policy scientific papers. Pdf money information and uncertainty download read. Impact of monetary policy uncertainty on asian exchange. We propose a generalequilibrium theory of exchange rate determination based on the interaction between monetary policy and timevarying uncertainty.
We document that a trading strategy that is short the u. First, through its effect on the exchange rate, it can directly counteract exchange rate swings that would have undesired effects on the inflation rate and on the real economy. The analysis reveals that monetary policy uncertainty tends to increase the variance of exchange rates, with heterogenous effects across asian economies. In the presence of higher monetary policy uncertainty, the reactions of the equity and crude oil futures markets to macroeconomic news weaken, and the reactions of the treasury and foreign exchange. Philippe mueller, alireza tahbazsalehi and andrea vedolin. The uncertainty adjusted model allows us to investigate whether monetary policy is more aggressive or passive when uncertainty about the relevant exogenous variable increases. Lse research online documents on economics from london school of economics and political science, lse library. Exchange rates and monetary policy uncertainty philippe mueller, alireza tahbazsalehi, and andrea vedolin abstract we document that a trading strategy that is short the u. Following an increase in monetary policy uncertainty, the dollar exchange rate appreciates in the medium run, while an increase in the volatility of productivity leads to a dollar depreciation. The objective of this paper is to summarize and compare the main results that have emerged in the literature on optimal monetary policy under uncertainty with actual central bank behaviour. Marketbased monetary policy uncertainty san francisco fed.
A study of the role of money and the nature of markets in the modern, rapidly changing banking community. Monetary policy uncertainty and the market reaction to. Changes in the exchange rate have quite a powerful effect on the economy but we tend to assume ceteris paribus all other factors held constant which of course is highly unlikely to be the case. Our results show that the economic significance of exchange rate movements heightens during the referendum period.
Exchange rates and monetary policy uncertainty mueller. Some studies have been performed on monetary policy and its impact on the exchange rate both inside and outside the country, but they have not. Agents are uncertain about the true data generating model and deal with the model uncertainty by making inference on the. The currency depreciations underlined the large impact of us monetary policy on. Exchange rates and monetary policy uncertainty, 2016 meeting papers 8, society for economic dynamics. We thus interpret the impact of monetary policy uncertainty on currency excess returns as a preannouncement effect. The effects of conventional and unconventional monetary. Focusing on simple rules in which the federal reserve is assumed to set the federal funds rate in response to inflation, the output gap that is, the difference between actual output and an estimate of potential output, and the lagged federal funds rate. S ii increase with uncertainty about monetary policy. Counterbalancing use of fiscal and monetary policy. Simple monetary policy rules and exchange rate uncertainty.
Exchange rates and monetary policy uncertainty by philippe. The effects are of comparable magnitude to those of conventional monetary policy shocks. The role of the exchange rate in monetary policy in poland piotr banbula,1 witold kozinski2 and michal rubaszek3, 4 1. Uk policy uncertainty, monetary policy stance and exchange. Exchange rates and monetary policy uncertainty core. The role of the exchange rate in monetary policy in poland. To this end, three examples are studied in which uncertainty played a significant role in the bank of canada s policy decision, to see how closely they. With any future change in fiscal policy quite uncertain, monetary policy will be guided by the current state of the economy, the underlying momentum of economic activity and inflation, the level of the neutral rate, and the balance of macroeconomic risks. Our analysis suggests that policy rate normalization that is accompanied by reduced uncertainty can help neutralize the contractionary effects of the rate. Introduction as described by the impossible trinity, countries can choose only two out of three from among full monetary policy independence, full nominal exchange rate stability and full financial integration. Inflation, output gap and exchange rate uncertainty estimates were derived. Exchange rates and monetary policy uncertainty, lse research online documents on economics 66043, london school of economics and political science, lse library. Exchange rates and monetary policy uncertainty 1219 in addition to investors, the economy is populated by a unit mass of identical riskneutral.
Monetary policy, model uncertainty and exchange rate. Central bank policy, exchange rate intervention, competitive devaluations, financial crisis jel classification. The impact of monetary policies on the exchange rate. Exchange rates and monetary policy frameworks in emerging. Evaluation points on the effects of exchange rate changes. Exchange rates and monetary policy uncertainty, lse research online documents on economics 77256, london school of economics and political science, lse library. For example the government can alter fiscal policy to manage ad. Price stability reduces uncertainty in the economy and, therefore, provides a favourable environment for growth and employment creation.
This pdf is a selection from an outofprint volume from the national bureau. Here, the monetary authority uses the nominal exchange rate as the instrument of monetary policy, but instead of keeping it fixed, it announces a path of the rate allowed for appreciation or depreciation based. Simple monetary policy rules and exchange rate uncertainty pdf 594kb discussants. Uncertainty and monetary policy federal reserve bank of. Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. We examine whether monetary policy uncertainty influences the reaction of the equity, treasury security, foreign exchange and crude oil markets, as well as mediumterm interest rates. Exchange rates and monetary policy uncertainty lse. However, the exchange rate depreciation following an unconventional monetary policy easing is mostly due to changes in expectations. Exchange rate levels and fluctuations are key economic variables that affect international trade and investment.
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