Monetary Policy Surprises and Exchange Rate Behavior

Refet S. Gürkaynak, A. Hakan Kara, Burçin Kısacıkoğlu, Sang Seok Lee

Chapter in NBER book NBER International Seminar on Macroeconomics 2020 (2021), Linda Tesar, editor
Conference held June 18-19, 2020
Published in May 2021 by Elsevier, Journal of International Economics, volume 130, May 2021
in NBER Book Series NBER International Seminar on Macroeconomics

Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciate as predicted by standard models. We document this for Fed and ECB policy days using event studies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy, may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism, we condition on multiple asset prices in the event study and model implications for these. We find that there is heterogeneity in this dimension in the event study and no model with a single regime can match the evidence. Further, even after conditioning on possible information effects driving longer term interest rates, there appear to be other drivers of exchange rates. Our results show that existing models have a long way to go in reconciling event study analysis with model-based mechanisms of asset pricing.

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Document Object Identifier (DOI): 10.1016/j.jinteco.2021.103443