Working Paper: NBER ID: w27746
Authors: Kristin Forbes; Ida Hjortsoe; Tsvetelina Nenova
Abstract: We analyse the economic conditions (the “shocks”) behind currency movements and show how that analysis can help address a range of questions, focusing on exchange rate pass-through to prices. We build on a methodology previously developed for the United Kingdom and adapt this framework so that it can be applied to a diverse sample of countries using widely available data. The paper provides three examples of how this enriched methodology can be used to provide insights on pass-through and other questions. First, it shows that exchange rate movements caused by monetary policy shocks consistently correspond to significantly higher pass-through than those caused by demand shocks in a cross-section of countries, confirming earlier results for the UK. Second, it shows that the underlying shocks (especially monetary policy shocks) are particularly important for understanding the time-series dimension of pass-through, while the standard structural variables highlighted in previous literature are most important for the cross-section dimension. Finally, the paper explores how the methodology can be used to shed light on the effects of monetary policy and the debate on "currency wars": it shows that the role of monetary policy shocks in driving the exchange rate has increased moderately since the global financial crisis in advanced economies.
Keywords: exchange rate passthrough; monetary policy shocks; demand shocks; inflation dynamics
JEL Codes: E31; E37; E52; F47
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 Movements (F31) |
| Exchange Rate Movements (F31) | Passthrough to Prices (P22) |
| Demand Shocks (E39) | Exchange Rate Movements (F31) |
| Monetary Policy Shocks (E39) | Higher Passthrough (H22) |
| Domestic Demand Shocks (D12) | Lower Passthrough (H22) |
| Underlying Shocks (E32) | Passthrough (Y60) |
| Structural Variables (C39) | Passthrough (Y60) |
| Monetary Policy Shocks (E39) | Exchange Rate Volatility (F31) |