Working Paper: NBER ID: w28108
Authors: Ethan Ilzetzki; Carmen M. Reinhart; Kenneth S. Rogoff
Abstract: Over the 21st century, and especially since 2014, global exchange rate volatility has been trending downwards, notably among the core G3 currencies (dollar, euro and the yen), and to some extent the G4 (including China). This stability continued through the Covid-19 recession to date: unusual, as exchange volatility generally rises in US recessions. Compared to measures of stock price volatility, exchange rate volatility rivals the lows reached in the heyday of Bretton Woods I. This paper argues that the core driver is convergence in monetary policy, reflected in a sharp-reduction of inflation and short- and especially long-term interest rate differentials. This unprecedented stability, which partially extends to emerging markets, is strongly reinforced by expectations that the zero bound will be significantly binding for advanced economies for years to come. We consider various hypotheses and suggest that the shutdown of monetary volatility is the leading explanation. The concluding part of the paper cautions that systemic economic crises often produce major turning points, so a collapse of the Extended Bretton Woods II regime cannot be ruled out.
Keywords: exchange rate volatility; inflation volatility; COVID-19; monetary policy
JEL Codes: E5; F3; F4; N2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| convergence in monetary policy (E49) | reduced inflation (E31) |
| convergence in monetary policy (E49) | reduced interest rate differentials (E43) |
| reduced inflation (E31) | stability in exchange rates (F31) |
| reduced interest rate differentials (E43) | stability in exchange rates (F31) |
| zero lower bound on interest rates (E43) | stability in exchange rates (F31) |
| collapse in international interest differentials (F44) | stability in exchange rates (F31) |
| COVID-19 shock (H12) | uncertainty in exchange rate volatility (F31) |
| systemic economic crises (P34) | turning points in exchange rate regime (F31) |