Publications - Working Papers IER SAS

Contractionary monetary policy tends to appreciate the exchange rate, which might amplify the macroeconomic effects of monetary policy. We use Bayesian structural VAR model to study the role of exchange rate in the transmission of monetary policy in the Euro Area (EA). We distinguish between pure monetary policy shocks and central bank information shocks. We find that contractionary monetary policy appreciates the Euro exchange rate, and decreases real output and consumer prices. Using a counterfactual analysis, we then construct a counterfactual scenario where the exchange rate does not respond to monetary policy shocks and we contrast this counterfactual with our baseline findings. In the absence of exchange rate appreciation, the transmission of monetary policy shocks to both real output and consumer prices is weaker, indicating that the exchange rate channel plays some role in amplifying the transmission of monetary policy in the Euro Area. Exchange rate also plays a larger role in the transmission of non-standard monetary policies, such as the forward guidance and large-scale asset purchases, than in the transmission of standard monetary policy. Finally, we find that the exchange rate does not influence the transmission of central bank information shocks.