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Money's Causal Role in Exchange Rate: Do Divisia Monetary Aggregates Explain More?

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  • Soumya Bhadury

    (National Council of Applied Economic Research)

  • Taniya Ghosh

    (Indira Gandhi Institute of Development Research (IGIDR), Mumbai)

Abstract

We investigate the predictive power of Divisia monetary aggregates in explaining exchange rate variations for India, Israel, Poland, UK and the US, in the years leading up to and following the 2007-08 recessions. One valid concern for the chosen sample period is that the interest rate has been stuck at or near the zero lower bound (ZLB) for some major economies. Consequently, the interest rate has become uninformative about the monetary policy stance. An important innovation in our research is to adopt the Divisia monetary aggregate as an alternative to the policy indicator variable. We apply bootstrap Granger causality method which is robust to the presence of non-stationarity in our data. Additionally, we use bootstrap rolling window estimates to account for the problems of parameter non-constancy and structural breaks in our sample covering the Great recession. We find strong causality from Divisia money to exchange rates. By capturing the time-varying link of Divisia money to exchange rate, the importance of Divisia is further established at ZLB.

Suggested Citation

  • Soumya Bhadury & Taniya Ghosh, 2018. "Money's Causal Role in Exchange Rate: Do Divisia Monetary Aggregates Explain More?," NCAER Working Papers 113, National Council of Applied Economic Research.
    • Handle: RePEc:nca:ncaerw:113
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    2. Yemba, Boniface P. & Otunuga, Olusegun Michael & Tang, Biyan & Biswas, Nabaneeta, 2023. "Nowcasting of the Short-run Euro-Dollar Exchange Rate with Economic Fundamentals and Time-varying Parameters," Finance Research Letters, Elsevier, vol. 52(C).
    3. Belongia, Michael T. & Ireland, Peter N., 2024. "The transmission of monetary policy shocks through the markets for reserves and money," Journal of Macroeconomics, Elsevier, vol. 80(C).
    4. Bhadury, Soumya & Ghosh, Saurabh & Gopalakrishnan, Pawan, 2021. "In quest for policy 'silver bullets' towards triggering a v-shaped recovery," MPRA Paper 110905, University Library of Munich, Germany.

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    More about this item

    Keywords

    Monetary Policy; Divisia Monetary Aggregates; Simple Sum; Nominal Exchange Rate; Real Effective Exchange Rate; Bootstrap Granger Causality;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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