Working Paper: CEPR ID: DP15289
Authors: Refet S. Grkaynak; A. Hakan Kara; Burin Ksackoglu; Sang Seok Lee
Abstract: Central banks unexpectedly tightening policy rates often observe the exchange valueof their currency depreciate, rather than appreciate as predicted by standard models.We document this for Fed and ECB policy days using eventstudies and ask whetheran information effect, where the public attributes the policy surprise to an unobservedstate of the economy that the central bank is signaling by its policy may explain theabnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism,we condition on multiple asset prices in the eventstudy and model implications for these.We find that there is heterogeneity in this dimension in the eventstudy and no modelwith a single regime can match the evidence. Further, even after conditioning on possibleinformation effects driving longer term interest rates, there appear to be other drivers ofexchange rates. Our results show that existing models have a long way to go in reconcilingeventstudy analysis with model-based mechanisms of asset pricing.
Keywords: exchange rate response to monetary policy; central bank information effect; open economy macrofinance modeling
JEL Codes: E43; E44; E52; E58; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy surprises (E39) | Exchange rate behavior (F31) |
| Unexpected tightening of policy rates (E52) | Depreciation of currency (F31) |
| Policy surprises signal unobserved states of the economy (D80) | Exchange rate reactions (F31) |
| Information effects (G14) | Other drivers of exchange rates (F31) |