The Effects of Conventional and Unconventional Monetary Policy on Exchange Rates

64 Pages Posted: 17 Sep 2018 Last revised: 15 May 2022

See all articles by Atsushi Inoue

Atsushi Inoue

Vanderbilt University - College of Arts and Science - Department of Economics

Barbara Rossi

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics

Date Written: September 2018

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 periods in the US by using a novel identification procedure that defines monetary policy shocks as changes in the 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 substantial 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.

Suggested Citation

Inoue, Atsushi and Rossi, Barbara, The Effects of Conventional and Unconventional Monetary Policy on Exchange Rates (September 2018). NBER Working Paper No. w25021, Available at SSRN: https://ssrn.com/abstract=3250538

Atsushi Inoue (Contact Author)

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States

Barbara Rossi

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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