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The open economy consequences of U.S. monetary policy

The open economy consequences of U.S. monetary policy
The open economy consequences of U.S. monetary policy
A failure to identify movements in the federal funds rate that are both unpredictable and independent of other determinants of open economy variables may lead to attenuation bias in the estimated effects of U.S. monetary policy on the exchange rate and foreign variables. Using a U.S. monetary policy measure which isolates unpredictable and independent federal funds rate changes, we quantify the magnitude of the attenuation bias for the exchange rate and foreign variables. The exchange rate appreciation following a monetary contraction is up to 4 times larger than a recursively-identified VAR estimate. There is stronger evidence of foreign interest rate pass-through. The expenditure-reducing effects of a U.S. monetary policy contraction dominate any expenditure-switching effects, leading to a positive conditional correlation of international outputs and prices. We compare our results with those obtained using identification based upon: (1) non-recursive VAR restrictions; and, (2) restrictions derived from high frequency asset price behavior.
open economy monetary policy identification, exchange rate adjustment, interest rate pass-through
Nuffield College
Bluedorn, John C.
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Bowdler, Christopher
7f89c248-64f6-4462-87fb-c14c4ac1a49c
Bluedorn, John C.
f2ebe71c-2c3a-443b-a88c-659bcd483b3a
Bowdler, Christopher
7f89c248-64f6-4462-87fb-c14c4ac1a49c

Bluedorn, John C. and Bowdler, Christopher (2006) The open economy consequences of U.S. monetary policy (Nuffield College Economics Paper) Oxford, UK. Nuffield College 43pp.

Record type: Monograph (Working Paper)

Abstract

A failure to identify movements in the federal funds rate that are both unpredictable and independent of other determinants of open economy variables may lead to attenuation bias in the estimated effects of U.S. monetary policy on the exchange rate and foreign variables. Using a U.S. monetary policy measure which isolates unpredictable and independent federal funds rate changes, we quantify the magnitude of the attenuation bias for the exchange rate and foreign variables. The exchange rate appreciation following a monetary contraction is up to 4 times larger than a recursively-identified VAR estimate. There is stronger evidence of foreign interest rate pass-through. The expenditure-reducing effects of a U.S. monetary policy contraction dominate any expenditure-switching effects, leading to a positive conditional correlation of international outputs and prices. We compare our results with those obtained using identification based upon: (1) non-recursive VAR restrictions; and, (2) restrictions derived from high frequency asset price behavior.

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More information

Published date: 1 July 2006
Keywords: open economy monetary policy identification, exchange rate adjustment, interest rate pass-through

Identifiers

Local EPrints ID: 42733
URI: https://eprints.soton.ac.uk/id/eprint/42733
PURE UUID: 11dd5526-ac01-4860-abb5-87187b6ee84d

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Date deposited: 18 Jan 2007
Last modified: 13 Mar 2019 21:11

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Contributors

Author: John C. Bluedorn
Author: Christopher Bowdler

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