Some Empirical Evidence on the Effects of Monetary Policy Shocks on Exchange Rates

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This paper presents new empirical evidence on the effects of monetary policy shocks on U.S. exchange rates, both nominal and real. Three measures of monetary policy shocks are considered: orthogonalized shocks to the Federal Funds rate, the ratio of Non Borrowed to Total Reserves and the Romer and Romer (1989) index. Using data from the flexible exchange rate era, we find that expansionary shocks to U.S. monetary policy lead to sharp. persistent depreciations in U.S. nominal and real exchange rates as well as to sharp. persistent increases in the spread between various foreign and U.S. interest rates. The temporal pattern of the depreciation in U.S. nominal exchange rates following a positive monetary policy shock is inconsistent with simple overshooting models of the type considered by Dornbusch (1976). We also find that U.S. monetary policy was less volatile under fixed exchange rates than under floating exchange rates. Finally, we find less evidence that monetary policy shocks had a significant impact on U.S. real exchange rates under the Bretton Woods agreement.

Published: Quarterly Journal of Economics, Nov 1995, pp. 1975-1010.

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