Skip to main content

Research Repository

Advanced Search

Monetary Policy and Exchange Rates: A Balanced Two-Country Cointegrated VAR Model Approach

Monetary Policy and Exchange Rates: A Balanced Two-Country Cointegrated VAR Model Approach Thumbnail


Abstract

We study the exchange rate effects of monetary policy in a balanced macroeconometric two-country model for the US and UK. In contrast to the empirical literature on the `delayed overshooting puzzle', which consistently treats the domestic and foreign countries unequally in the modelling process, we consider the full model feedback, allowing for a thorough analysis of the system dynamics. The consequential inevitable problem of model dimensionality is tackled in this paper by invoking the approach by Aoki (1981) commonly used in economic theory. Assuming country symmetry in the long-run allows to decouple the two-country macro dynamics of country averages and country differences such that the cointegration analysis can be applied to much smaller systems. Secondly the econometric modelling is general-to-specific, a graph-theoretic approach for the contemporaneous effects combined with an automatic general-to-specific model selection. The resulting parsimonious structural vector equilibrium correction model ensures highly significant impulse responses, revealing a delayed overshooting of the exchange rate in the case of a Bank of England monetary shock but suggests an instantaneous response to a Fed shock. Altogether the response is more pronounced in the former case.

Acceptance Date Mar 21, 2017
Publication Date Jul 19, 2019
Journal Macroeconomic Dynamics
Print ISSN 1365-1005
Publisher Cambridge University Press
Pages 1838-1874
DOI https://doi.org/10.1017/S1365100517000475
Keywords economics, macroeconomics, monetary policy
Publisher URL https://doi.org/10.1017/S1365100517000475

Files







Downloadable Citations