Unconventional policies and exchange rate dynamics

Abstract

We study exchange rate dynamics under cooperative and self-oriented policies in a two-country DSGE model with unconventional monetary and exchange rate policies. The cooperative solution features a large exchange rate adjustment that cushions the impact of negative shocks and a moderate use of unconventional policy instruments. Self-oriented policies (Nash equilibrium), however, entail limited exchange rate movements and an aggressive use of unconventional policies in both countries. Our results suggest that sizable exchange rate depreciations are not always a symptom of “beggar-thy-neighbor” policies. They could also reflect a desirable process of external adjustment that improves global welfare.