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Effects of Monetary Policy on the US Dollar/UK Pound Exchange Rate. Is There a "Delayed Overshooting Puzzle"?

Heinlein, Reinhold; Krolzig, Hans Martin

Authors

Hans Martin Krolzig



Abstract

The determination of the US dollar/UK pound sterling exchange rate is studied in a small symmetric macroeconometric model including UK-US differentials in inflation, output gap, and short- and long-term interest rates for the four decades since the breakdown of Bretton Woods. The key question addressed is the possible presence of a "delayed overshooting puzzle" in the dynamic reaction of the exchange rate to monetary policy shocks. In contrast to the existing literature, we follow a data-driven modeling approach combining (i) a vector autoregression (VAR)-based cointegration analysis with (ii) a graph-theoretic search for instantaneous causal relations and (iii) an automatic general-to-specific approach for the selection of a congruent parsimonious structural vector equilibrium correction model. We find that the long-run properties of the system are characterized by four cointegration relations and one stochastic trend, which is identified as the long-term interest rate differential and that appears to be driven by long-term inflation expectations as in the Fisher hypothesis. It cointegrates with the inflation differential to a stationary "real" long-term rate differential and also drives the exchange rate. The short-run dynamics are characterized by a direct link from the short-term to the long-term interest rate differential. Jumps in the exchange rate after short-term interest rate variations are only significant at 10%. Overall, we find strong evidence for delayed overshooting and violations of uncovered interest rate parity (UIP) in response to monetary policy shocks. © 2012 Blackwell Publishing Ltd.

Journal Article Type Article
Online Publication Date Jul 16, 2012
Publication Date Aug 1, 2012
Deposit Date Sep 18, 2019
Publicly Available Date Sep 19, 2019
Journal Review of International Economics
Print ISSN 0965-7576
Electronic ISSN 1467-9396
Publisher Wiley
Peer Reviewed Peer Reviewed
Volume 20
Issue 3
Pages 443-467
DOI https://doi.org/10.1111/j.1467-9396.2012.01033.x
Public URL https://uwe-repository.worktribe.com/output/2718310
Contract Date Sep 18, 2019

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Copyright Statement
This is the peer reviewed version of the following article: Heinlein, R., & Krolzig, H. (2012). Effects of monetary policy on the US Dollar/UK Pound exchange rate. Is there a `delayed overshooting puzzle'?. Review of International Economics, 20(3), 443-467, which has been published in final form at https://doi.org/10.1111/j.1467-9396.2012.01033.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving





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