DP2079 Measuring Monetary Policy in Open Economies

Author(s): Fabio-Cesare Bagliano , Carlo A. Favero , Francesco Franco

Publication Date: February 1999

Keyword(s): Exchange Rates , implicit forward rate curve , Monetary Policy , VAR models

JEL(s): E44 , E52 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP2079.asp

The empirical VAR literature on the monetary transmission mechanism in open economies has not yet provided a commonly accepted solution to the problem of simultaneity between interest rates and the exchange rate. In this paper we propose to solve the identification problem by using information extracted from financial markets independently from the VAR to measure monetary policy shocks. We also evaluate the relative importance of macroeconomic and monetary policy variables in explaining short-term fluctuations in the nominal exchange rate. Our main results are that the simultaneity between German policy rates and the US\ dollar/D Mark exchange rate is not an empirically relevant problem, and that monetary variables are dominated by macroeconomic factors in the explanation of exchange rate fluctuations.