ECB policy response to the Euro
Gürkaynak, Refet S.
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The exchange rate is an important part of transmission mechanism in the determination of monetary policy because movements in the exchange rate has signiÖcant e§ect on the macroeconomy. Measuring the reaction of monetary policy to the movements in exchange rate has some di¢ culties due to the simultaneous response of monetary policy on the exchange rate and the possibility that both variables respond several other variables. This study will use an identiÖcation method based on the heteroscedasticity in the high-frequency data. In particular, shifts in the importance of exchange rate relative to monetary policy shocks, and the estimated changes in the covariance between the shocks that result, allow us to measure the reaction of interest rates to changes in exchange rates. This study comes up with unbiased estimates with heteroscedasticity based identiÖcation approach and results of this paper suggest that ECB systematically respond to the exchange rate movements but that quantitative e§ects are small. The empirical results indicate that a 1 point rise (fall) in the exchange rate tends to decrease (increase) the three-month interest rate by around 20 basis points. Small and negative reaction coe¢ cient implies that ECB may respond to the movements in exchange rate only to the extent warranted by their impact on the macroeconomy, since it a§ects the expected ináation and future output path.
IdentiÖcation through Heteroscedasticity
European Central Bank