Working Paper: CEPR ID: DP2079
Authors: Fabio C. Bagliano; Carlo A. Favero; Francesco Franco
Abstract: The empirical VAR literature on the monetary transmission mechanism inopen economies has not yet provided a commonly accepted solution to theproblem of simultaneity between interest rates and the exchange rate. Inthis paper we propose to solve the identification problem by usinginformation extracted from financial markets independently from the VAR tomeasure monetary policy shocks. We also evaluate the relative importance ofmacroeconomic and monetary policy variables in explaining short-termfluctuations in the nominal exchange rate. Our main results are that thesimultaneity between German policy rates and the US\ dollar/D Mark exchangerate is not an empirically relevant problem, and that monetary variablesare dominated by macroeconomic factors in the explanation of exchange ratefluctuations.
Keywords: monetary policy; VAR models; exchange rates; implicit forward rate curve
JEL Codes: E44; E52; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy shocks (E39) | Exchange rate fluctuations (F31) |
| Simultaneity issue (C41) | Identification of exogenous shocks (E32) |
| Macroeconomic factors (E66) | Exchange rate fluctuations (F31) |
| Monetary variables (E39) | Exchange rate fluctuations (F31) |