Working Paper: NBER ID: w25380
Authors: Stephanie Schmitt-Groh; Martn Uribe
Abstract: This paper estimates an empirical model of exchange rates and uncovered interest rate differentials with permanent U.S. monetary policy shocks. Using post-Bretton-Woods data from the United States, the United Kingdom, Japan, and Canada, it reports two main findings: First, monetary shocks that increase the U.S. nominal interest rate and inflation in the long run depreciate the dollar in nominal and real terms in the short run. Second, permanent increases in the U.S. interest rate cause short-run deviations from uncovered interest-rate parity against U.S. assets. The signs of these effects are opposite to those reported in the related literature for transitory monetary policy shocks. The estimated responses to transitory and permanent monetary shocks are shown to be qualitatively consistent with the predictions of a new Keynesian model of the open economy with portfolio adjustment costs.
Keywords: exchange rates; uncovered interest differentials; permanent monetary shocks
JEL Codes: E4; F3; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| U.S. nominal interest rate and inflation due to permanent monetary shocks (E49) | depreciation of the dollar in both nominal and real terms (F31) |
| Permanent increases in the U.S. interest rate (E43) | short-run deviations from uncovered interest rate parity against U.S. assets (F31) |
| Transitory monetary shocks (E39) | persistent appreciation of the domestic currency (F31) |