Working Paper: CEPR ID: DP13597
Authors: Gernot M"uller; Martin Wolf; Thomas Hettig
Abstract: We reconsider the delayed overshooting puzzle through the lens of a New Keynesian model with information rigidities. In the model, market participants do not directly observe the natural rate of interest and learn from unanticipated shifts in monetary policy about the state of the economy. We estimate the model and find that it can account for the joint responses of spot and forward exchange rates, excess returns, and macroeconomic indicators to monetary policy shocks. Our results suggest that information rigidities are important for understanding exchange rate dynamics.
Keywords: exchange rate; forward exchange rates; excess return; UIP puzzle; monetary policy; information effect; information rigidities
JEL Codes: F31; E43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Information rigidities (D89) | Misinterpretation of monetary policy shocks (E39) |
| Information rigidities (D89) | Lack of predictive power for future exchange rate movements (F31) |
| Monetary policy shocks (E39) | Dollar appreciation (F31) |
| Dollar appreciation (F31) | Gradual appreciation consistent with delayed overshooting (D15) |
| Monetary policy shocks (E39) | Persistent excess return against major currencies (F31) |
| Persistent excess return against major currencies (F31) | Dissipation over time (D15) |