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Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation

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  • Wei Dong

Abstract

This paper investigates the impact of exchange rate movements on the conduct of monetary policy in Australia, Canada, New Zealand and the United Kingdom. We develop and estimate a structural general equilibrium two-sector model with sticky prices and wages and limited exchange rate pass-through. Different specifications for the monetary policy rule and the real exchange rate process are examined. The results indicate that the Reserve Bank of Australia, the Bank of Canada and the Bank of England paid close attention to real exchange rate movements, whereas the Reserve Bank of New Zealand did not seem to incorporate exchange rate movements explicitly into their policy rule. With a higher degree of intrinsic inflation persistence, the central bank of New Zealand seems less concerned about future inflation pressure induced by current exchange rate movements. In addition, the structure of the shocks driving inflation and output variations in New Zealand is such that it may be sufficient for the Reserve Bank of New Zealand to only respond to exchange rate movements indirectly through stabilizing inflation and output.

Suggested Citation

  • Wei Dong, 2008. "Do Central Banks Respond to Exchange Rate Movements? Some New Evidence from Structural Estimation," Staff Working Papers 08-24, Bank of Canada.
    • Handle: RePEc:bca:bocawp:08-24
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    Cited by:

    1. Baxa, Jaromír & Horváth, Roman & Vašíček, Bořek, 2014. "How Does Monetary Policy Change? Evidence On Inflation-Targeting Countries," Macroeconomic Dynamics, Cambridge University Press, vol. 18(3), pages 593-630, April.
    2. Moayad H. Al Rasasi, 2018. "The Response of G7 Real Exchange Rates to Oil Price Shocks," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 10(4), pages 191-205, April.
    3. Hilde C. Bjørnland & Jørn I. Halvorsen, 2014. "How does Monetary Policy Respond to Exchange Rate Movements? New International Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 76(2), pages 208-232, April.
    4. T. Philipp Dybowski & Max Hanisch & Bernd Kempa, 2018. "The role of the exchange rate in Canadian monetary policy: evidence from a TVP-BVAR model," Empirical Economics, Springer, vol. 55(2), pages 471-494, September.
    5. Caraiani, Petre & Gupta, Rangan, 2020. "Is the response of the bank of England to exchange rate movements frequency-dependent?," Journal of Macroeconomics, Elsevier, vol. 63(C).
    6. Carlos Garcia & Jorge Restrepo & Mr. Scott Roger, 2009. "Hybrid Inflation Targeting Regimes," IMF Working Papers 2009/234, International Monetary Fund.
    7. Araújo, Eurilton, 2016. "Determinacy and learnability of equilibrium in a small-open economy with sticky wages and prices," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 16-32.
    8. Luangaram, Pongsak & Wongpunya, Nipit, 2024. "The effect of trade openness and exchange rate on inflation targeting in Thailand," Journal of Asian Economics, Elsevier, vol. 92(C).
    9. Caraiani, Petre, 2013. "Comparing monetary policy rules in CEE economies: A Bayesian approach," Economic Modelling, Elsevier, vol. 32(C), pages 233-246.
    10. Gelfer, Sacha, 2021. "Evaluating the forecasting power of an open-economy DSGE model when estimated in a data-Rich environment," Journal of Economic Dynamics and Control, Elsevier, vol. 129(C).
    11. Berg, Kimberly A. & Mark, Nelson C., 2015. "Third-country effects on the exchange rate," Journal of International Economics, Elsevier, vol. 96(2), pages 227-243.
    12. Becksndale Masawi & Sukanto Bhattacharya & Terry Boulter, 2018. "Does the Information Content of Central Bank Speeches Impact on the Level of Exchange Rate? A Comparative Study of Canadian and Australian Central Bank Communications," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 21(01), pages 1-27, March.
    13. Carlos Garcia & Jorge Restrepo & Scott Roger, 2009. "Hybrid Inflation Targeting Regimes1," ILADES-UAH Working Papers inv226, Universidad Alberto Hurtado/School of Economics and Business.
    14. Pongsak Luangaram & Nipit Wongpunya, 2022. "Exploring the Role of Exchange Rate in Inflation Targeting: Evidence from Thailand," PIER Discussion Papers 179, Puey Ungphakorn Institute for Economic Research.
    15. Eurilton Araújo & Débora Gouveia, 2013. "Calvo-type rules and the forward-looking behavior of inflation targeting central banks," Economics Bulletin, AccessEcon, vol. 33(3), pages 2042-2051.
    16. Garcia, Carlos J. & Restrepo, Jorge E. & Roger, Scott, 2011. "How much should inflation targeters care about the exchange rate?," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1590-1617.
    17. Ronald H. Lange, 2013. "Monetary policy reactions and the exchange rate: a regime-switching structural VAR for Canada," International Review of Applied Economics, Taylor & Francis Journals, vol. 27(5), pages 612-632, September.
    18. Mr. Scott Roger, 2009. "Inflation Targeting at 20 - Achievements and Challenges," IMF Working Papers 2009/236, International Monetary Fund.
    19. Sergi Bruno S. & Hsing Yu, 2010. "Responses of Monetary Policy to Inflation, the Output Gap, and Real Exchange Rates: The Case of Australia, Canada, and New Zealand," Global Economy Journal, De Gruyter, vol. 10(2), pages 1-11, May.
    20. Alex Ilek & Guy Segal, 2022. "A Simple Theory-Based Estimate of the Real Natural Rate of Interest in Open Economies," Bank of Israel Working Papers 2022.06, Bank of Israel.
    21. Alstadheim, Ragna & Bjørnland, Hilde C. & Maih, Junior, 2021. "Do central banks respond to exchange rate movements? A Markov-switching structural investigation of commodity exporters and importers," Energy Economics, Elsevier, vol. 96(C).
    22. Montes, Gabriel Caldas & Ferreira, Caio Ferrari, 2020. "Does monetary policy credibility mitigate the fear of floating?," Economic Modelling, Elsevier, vol. 84(C), pages 76-87.

    More about this item

    Keywords

    Exchange rates; Monetary policy framework; International topics;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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    1. Canadian Macro Study Group

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