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Interest Rates, Global Risk and Inflation Expectations: Drivers of US Dollar Exchange Rates

Author

Listed:
  • Bernoth, Kerstin
  • Herwartz, Helmut
  • Trienens, Lasse

Abstract

Using a data-driven identification approach of structural vector autoregressive models, we analyse the factors driving the US dollar exchange rate for a sample of eight advanced countries over the period 1980M1 to 2022M6. We find that the exchange rates are significantly affected not only by US monetary policy, but also by shocks to inflation expectations associated with shifts in fiscal sustainability concerns. In addition, external shocks related to global risk aversion and the convenience yield that investors are willing to give up to hold US dollar assets have a significant impact on the US dollar exchange rate. All three shocks considered make an important contribution to explaining US dollar exchange rate changes, with external shocks being the most impactful on average. Moreover, we find evidence that the monetary policy response to shocks to long-run inflation expectations has changed over time, suggesting shifts in monetary policy reaction functions.

Suggested Citation

  • Bernoth, Kerstin & Herwartz, Helmut & Trienens, Lasse, 2024. "Interest Rates, Global Risk and Inflation Expectations: Drivers of US Dollar Exchange Rates," VfS Annual Conference 2024 (Berlin): Upcoming Labor Market Challenges 302351, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc24:302351
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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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