DP15289 Monetary Policy Surprises and Exchange Rate Behavior

Author(s): Refet S. Gürkaynak, A. Hakan Kara, Burçin Kisacikoglu, Sang Seok Lee
Publication Date: September 2020
Keyword(s): central bank information effect, Exchange rate response to monetary policy, open economy macro-finance modeling
JEL(s): E43, E44, E52, E58, G14
Programme Areas: International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15289

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 eventstudies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy that the central bank is signaling by its policy 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 eventstudy and model implications for these. We find that there is heterogeneity in this dimension in the eventstudy 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 eventstudy analysis with model-based mechanisms of asset pricing.