The next Economics Seminar of Paris-Saclay will take place on Thursday, December 1th from 12h15 to 13h15. Nicolas Groshenny (Le Mans) will present Dornbusch’s overshooting hypothesis and the systematic component of domestic and foreign monetary policy: new evidence from small open-economy SVARs (joint with Naveed Javed)
We estimate structural vector autoregressions (SVAR) models for four small open-economies (Australia, Canada, Norway and Sweden) to measure the effects of US and domestic monetary policy shocks on the bilateral (against the US dollar) real exchange rate. Our identification strategy combines block exogeneity (a classic feature of SOE SVARs) with sign-restrictions imposed directly on the coefficients of the domestic and US monetary policy rules. Our approach allows for simultaneous interactions between the exchange rate and the domestic and foreign policy rates. Our empirical results are consistent with Dornbusch’s overshooting hypothesis and UIP. In response to a contractionary domestic (foreign) monetary policy shock, the exchange rate appreciates (depreciates) strongly on impact, reaching its peak response immediately or shortly after the shock. The contribution of domestic and US monetary policy shocks to exchange rate fluctuations are roughly similar.