Effects of monetary policy on the exchange rates: A Time-varying analysis

Abstract

Employing a time-varying parameter vector autoregression (VAR) model, which is identified by high frequency monetary policy surprises, we examine the effects of monetary policy on the exchange rates. Our results indicate that a contractionary monetary policy shock leads to an appreciation of the exchange rate during both conventional and unconventional monetary policy periods in the US. During the period 2008–2012, when unconventional monetary policy was practiced, monetary policy shocks produced greater negative effects on the exchange rate compared with other periods. We find that the maximal appreciation of the exchange rate occurs within 3–4 months during most of the period, providing favorable evidence to support Dornbusch’s (1976) overshooting hypothesis.