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The Effect of Monetary Policy Actions on Exchange Rates Under Interest-Rate TargetingCatherine Bonser-Neal |
Abstract One puzzling feature of recent empirical studies of the effects of monetary policy changes on exchange rates is the result that the exchange rate does not adjust immediately to the policy shock. Instead, these studies find that it can take as long as two years for the exchange rate to fully reflect the policy change. In this paper, we specify a model of the exchange-rate response to U.S. monetary policy actions which captures these results. Our model also is capable of generating standard overshooting results. We show that the response pattern of spot and expected future exchange rates depends on the predictability of Federal Reserve actions, the persistence of shocks to the economy, and the reaction of foreign central banks to the U.S. monetary policy shock. Catherine Bonser-Neal is an associate professor at Indiana University School of Business at Indianapolis, V. Vance Roley is the Hughes M. Blake Professor of Business at the University of Washington and a visiting scholar at the Federal Reserve Bank of Kansas City, and Gordon H. Sellon, Jr., is an assistant vice president and economist at the Federal Reserve Bank of Kansas City. We are grateful to Kathryn Dewenter, Charles Engel, Craig Hakkio, Glenn Rudebusch, and Mark Spiegel for helpful comments on a previous draft of this paper. The views expressed herein are solely those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Board of Governors of the Federal Reserve System.Bonser-Neal e-mail: cneal@indyvax.iupui.edu
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