Working Paper: NBER ID: w23158
Authors: Martin Eichenbaum; Benjamin K. Johannsen; Sergio Rebelo
Abstract: This paper studies how the monetary policy regime affects the relative importance of nominal exchange rates and inflation rates in shaping the response of real exchange rates to shocks. We document two facts about inflation-targeting countries. First, the current real exchange rate predicts future changes in the nominal exchange rate. Second, the real exchange rate is a poor predictor of future inflation rates. We estimate a medium-size DSGE open-economy model that accounts quantitatively for these facts as well as other empirical properties of real and nominal exchange rates. The key estimated shocks that accounts for the dynamics of exchange rates and their covariance with inflation are disturbances to the foreign demand for dollar-denominated bonds.
Keywords: Monetary Policy; Exchange Rates; Inflation; DSGE Model
JEL Codes: E52; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current RER (R50) | future changes in NER (O39) |
| current RER decreases (R11) | future NER increases (O49) |
| current RER (R50) | future inflation rates (E31) |
| current RER (R50) | changes in NER (O39) |
| monetary policy regime (E63) | relationship between RER and NER (R50) |
| fixed exchange rate regime (F33) | RER adjustment through inflation differentials (F16) |