Aghion, Philippe, Philippe Bacchetta and Abhijit Banerjee, “A Simple Model of Monetary Policy and Currency Crises,”, European Economic Review 44 (2000), pp. 728-738.
Ammer, John and Richard T Freeman (1995), “Inflation Targeting in the 1990s: The Experiences of New Zealand, Canada, and the United Kingdom.” Journal of Economics and Business; Vol 47 No. 2 May 1995, pp. 165-92.
Bagliano, Fabio C. and Carlo A. Favero (1998), “Measuring Monetary Policy with VAR Models: An Evaluation,” European Economic Review, Vol. 42 No. 6, June 1998, pp. 1069- 1112.
Bagliano, Fabio C. and Carlo A. Favero (1999), “Information from Financial Markets and VAR Measures of Monetary Policy,” European Economic Review; Vol. 43, No. 4-6 April 1999, pp. 825-37.
Bank of Canada (1996b), Money Markets and Central Bank Operations. Proceedings of a conference held by the Bank of Canada in November 1995, Ottawa 1996.
Beatty, Neil and Jean-Francois Fillion (1999), “An Intraday Analysis of the Effectiveness of Foreign Exchange Intervention,” Working Paper 99-4, Bank of Canada.
Bonato, Leo, Robert St. Clair and Rainer Winckelmann (1999), “Survey Expectations of Monetary Conditions in New Zealand: Determinants and Implications for the Transmission of Policy, Reserve Bank of New Zealand G99/6, March 1999.
Campbell, Frank and Eleanor Lewis (1998), “What Moves Yields in Australia?” Reserve Bank of Australia Research Discussion Paper 9808, July 1998.
Christiano, Lawrence J., Martin Eichenbaum and Charles L. Evans (1998), “Monetary policy shocks: what have we learned and to what end?” NBER Working Paper 6400, February 1998.
Clinton, Kevin, “Bank of Canada cash management: The main technique for implementing monetary policy,” Bank of Canada Review, January 1991.
Clarida, Richard and Mark Gertler (1997), “How the Bundesbank conducts monetary policy,” in Christina D. Romer and David H. Romer (eds.), Reducing inflation: Motivation and Strategy, Chicago: University of Chicago Press, 1997, pp. 363-412.
Cook, Timothy and Thomas Hahn (1989), “The Effect of Changes in the Federal Funds Rate Target on Market Interest Rates in the 1970s,” Journal of Monetary Economics 24 (1989), 331-351.
Cushman, David O. and Tao Zha (1997), “Identifying Monetary Policy in a Small Open Economy under Flexible Exchange Rates,” Journal of Monetary Economics; Vol. 39 No. 3 August 1997, pp. 433-48.
Debelle, Guy (1996), “The Ends of Three Small Inflations: Australia, New Zealand and Canada,” Canadian Public Policy; Vol 22 No. 1, March 1996, pp. 56-78.
Dornbusch, Rudiger (1976), “Expectations and Exchange Rate Dynamics,” Journal of Political Economy Vol. 84 No. 6, December 1976, pp. 1161-76.
Drazen, Allan, “Interest Rate and Borrowing Defense Against Speculative Attack,” Paper prepared for the Carnegie-Rochester Conference Series on Public Policy, Pittsburgh, November 12-20, 1999.
Eichenbaum, Martin and Charles L. Evans, (1995), “Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates,” Quarterly Journal of Economics, Vol. 110 No. 4 November 1995, pp. 975-1009.
Faust, Jon, and John Rogers (1999), “Shooting Around: In Search of the Exchange Rate Response to Money Shocks,” unpublished draft, Board of Governors of the Federal Reserve, May 1999.
Flood, Robert, and Olivier Jeanne (2000), “An Interest Rate Defense of a Fixed Exchange Rate?” Unpublished draft, IMF Research Department, March 2000.
Fung, Benedict S. C. and Rohit Gupta (1997), “Cash Setting, the Call Loan Rate, and the Liquidity Effect in Canada,” Canadian Journal of Economics; Vol. 30 No. 4, November 1997, pp. 1057-82.
Furman. Jason and Joseph E. Stiglitz, “Economic Crises: Evidence and Insights from East Asia,” Brookings Papers on Economic Activity; 2/1998, pp. 1-114.
Goldfajn, Ilan and Poonam Gupta (1999), “Does Monetary Policy Stabilize the Exchange Rate Following a Currency Crisis?” IMF Working Paper WP/99/42.
Goldfajn, Ilan and Taimur Baig (1998), “Monetary Policy in the Aftermath of Currency Crisis: The Case of Asia,” IMF Working Paper WP/98/170
Gonzalez-Hermosillo, Brenda, and Takatoshi Ito, “The Bank of Canada’s Monetary Policy Framework: Have Recent Changes Enhanced Central Bank Credibility?” IMF Working Paper WP/97/171, Washington, D.C: International Monetary Fund.
Gosh, Atish and Steven Phillips (1999), “Monetary and Exchange Rate Policies,” in IMF-Supported Programs in Indonesia, Korea and Thailand. A Preliminary Assessment, IMF Occasional Paper 178, Washington, D.C.: International Monetary Fund, pp. 35-55.
Gould, David M. and Steven B. Kamin (2000), “The Impact of Monetary Policy on Exchange Rates During Financial Crises,” unpublished draft, Board of Governors of the Federal Reserve, January 2000.
Grilli, Vittorio and Nouriel Roubini (1995), “Liquidity and Exchange Rates: Puzzling Evidence From the G-7 Countries,” New York University: Salomon Brothers Working Paper: S/95/31, July 1995.
Grilli, Vittorio and Nouriel Roubini (1996), “Liquidity Models in Open Economies: Theory and Empirical Evidence,” European Economic Review, Vol. 40 No. 3-5 April 1996, pp. 847-59.
Hardy, Daniel C (1998), “Anticipation and Surprises in Central Bank Interest Rate Policy: The Case of the Bundesbank,” IMF Staff Papers, Vol. 45, No. 4, December 1998.
Huxford, J and M. Redell (1996), “Implementing Monetary Policy in New Zealand,” Reserve Bank of New Zealand Quarterly Bulletin 59 (4), 309-322.
Kasman, Bruce (1992), “A Comparison of Monetary Policy Operating Procedures in Six Industrial Countries,” Federal Reserve Bank of New York Quarterly Review, Vol. 17 No. 2, Summer 1992, pp. 5-24.
Kraay, Aart (1999), “Do High Interest Rates Defend Currencies During Speculative Attacks?” Unpublished draft, The World Bank, October 1999.
Lahiri, Amartya and Carlos Végh (2000a), “Delaying the Inevitable: Optimal Interest Rate Policy and BOP Crises,” NBER Working Paper No. 7734.
Mishkin, Frederic S.; Posen, Adam (1997), “Inflation Targeting: Lessons from Four Countries,” Federal Reserve Bank of New York Economic Policy Review; Vol. 3 No. 3, August 1997, pp. 9-110.
Murray, John, Mark Zelmer and Des McManus (1996), “The Effect of Intervention on Canadian Dollar Volatility,” in Exchange Rates and Monetary Policy: Proceedings of a conference held by the Bank of Canada, October 1996, pp. 311-356. Ottawa: Bank of Canada.
Ohno, Kenichi, Kazuko Shirono and Elif Sisli, “Can High Interest Rates Stop Regional Currency Falls?”, unpublished draft, Asian Development Bank.
Racette, Daniel and Jacques Raynauld (1992), “Canadian Monetary Policy: Will the Checklist Approach Ever Get Us to Price Stability?,” Canadian Journal of Economics Vol. 25, pp. 819-838.
Rudebusch, Glenn D. (1998), “Do Measures of Monetary Policy in a VAR Make Sense?” International Economic Review; Vol. 39 No. 4, November 1998, pp. 907-31.
Simone, Francisco Nadal-De and W. A. Razzak (1999), “Nominal Exchange Rates and Nominal Interest Rate Differentials,” IMF Working Paper WP/99/141.
Sims, Christopher A., “Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy,” European Economic Review; Vol. 36 No. 5 June 1992, pp. 975-1000.
Smets, Frank (1997), “Measuring Monetary Policy Shocks in France, Germany and Italy: The Role of the Exchange Rate,” Schweizerische Zeitschrift fur Volkswirtschaft und Statistik/Swiss Journal of Economics and Statistics Vol. 133 No. 3, September 1997, pp. 597-616.
- Search Google Scholar
- Export Citation
)| false ( Smets, Frank 1997), “ Measuring Monetary Policy Shocks in France, Germany and Italy: The Role of the Exchange Rate,” Schweizerische Zeitschrift fur Volkswirtschaft und Statistik/Swiss Journal of Economics and Statistics Vol. 133 No. 3, September 1997, pp. 597- 616.
Skinner, Tom and Jeromin Zettelmeyer (1995a), “Long Rates and Monetary Policy: Is Europe Different?,” in J. Zettelmeyer, Essays on Monetary Policy, MIT Ph.D. Dissertation, February 1995.
Skinner, Tom and Jeromin Zettelmeyer (1995b), “Identification and Effects of Monetary Policy Shocks—An Alternative Approach,” in J. Zettelmeyer, Essays on Monetary Policy, MIT Ph.D. Dissertation, February 1995.
Tanner, Evan (1999), “Exchange Market Pressure and Monetary Policy - Asia and Latin America in the 1990s,” IMF Working Paper WP/99/114.
I am very grateful to Andy Berg, Eduardo Borensztein, Roberto Cardarelli, Martin Cerisola, Guy Debelle, David Gruen, Paul Gruenwald, Luis-Oscar Herrera, Olivier Jeanne, Martin Kaufman, Paul Masson, Gian Maria Milest-Ferretti, John Murray. Francisco Nadal-de Simone, Saul Lizondo, Steven Phillips, Eswar Prasad, Raimundo Soto, and seminar participants at the Banco Central de Chile, Universidad Cat$o$lica de Chile and the IMF for comments, and to the Bank of Canada for kindly providing me with information on foreign exchange intervention policies during the sample period. Any views expressed in this paper are the author’s only and should not be attributed to the IMF
Sims (1992), Racette and Raynauld (1992), Eichenbaum and Evans (1995), Skinner and Zettelmeyer (1995b), Grilli and Roubini (1995, 1996), Clarida and Gertler (1997), Cushman and Zha (1997), Fung and Gupta (1997), Faust and Rogers (1998), Bagliano and Favero (1999), in addition to the papers on monetary policy after a currency crisis cited below.
This is argued by Furman and Stiglitz (1998); for two models that can rationalize their argument (under specific assumptions), see Aghion, Bacchetta and Banerjee (2000) and Lahiri and Végh (2000b). For theoretical papers on the related issue whether high interest rates are effective in defending exchange rate pegs see Drazen (1999), Lahiri and Végh (2000a) and Flood and Jeanne (2000). Empirical papers on the subject are referenced below.
For Canada, the G7, and Germany, respectively.
In general, studies that use interest rates as the policy variable are faced with a potential bias against finding a stabilizing effect of high interest rates on exchange rates, as partial accomodation of exchange market pressure by the monetary authorities would lead to both higher interest rates and a more depreciated exchange rate. In contrast, studies that use net domestic assets of the central bank as the policy variable are exposed to a potential bias in favor of finding a stabilizing effect of tight money on exchange rates, since partly accomodating a capital outflow would lead to both higher contemporaneous NDA and a more depreciated exchange rate.
This approach follows the literature on the effects of monetary policy on market (and in particular, longer term) interest rates. See Cook and Hahn (1989), Skinner and Zettelmeyer (1995a) and Hardy (1998), amongst others.
This is supported by a set of recent studies that examine the relationship between financial market volatility and scheduled news announcements using intra-day data, which find that “the price adjustment is largely completed within one minute, with volatility remaining significantly higher for 10-15 minutes after the release” (see Beattie and Pillion (1999), p. 11, and references therein). Specifically, Beattie and Fillion (1999) find that changes in the Bank of Canada operating band (its main policy target) did not increase market volatility beyond the first 20 minutes after the information is released.
One could attempt to integrate the identification approach used in this paper with a VAR analysis by simply using the sum of the shocks on the dates of policy actions in each month as an exogenous input (see Skinner and Zettelmeyer 1995b). However, this assumes that the dates at which we measure policy shocks are the only instances on which such shocks occur during a given month. Thus, when policy events are anticipated either because of the publication of relevant economic news prior to the action or because of statements by officials, this may not be a good measure, as it misses surprises that occur as relevant information becomes public prior to the actual policy event.
A conceptually attractive alternative that cannot be used in this paper for lack of data, but gives very similar results for the U.S. as the approach proposed, is to measure the policy surprise associated with a new target announcement as the difference between the new target and the one-month ahead overnight interest futures rate at t-1, along the lines of the monthly measure proposed by Rudebusch (1998). Alternatively, one could also estimate a daily measure of interest rate expectations using market data (Hardy (1998) and Bagliano and Favero (1998, 1999)). We do not take this route for two reasons. First, it adds a technically complex step to the overall method. Second, just like the approach proposed, estimation-based techniques obviously do not get the underlying monetary policy shock exactly right. Unlike the technique proposed, however, any remaining “measurement error” problem cannot be dealt with by using changes in the underlying policy target as an instrument (see discussion below), since this variable has already been used for the purposes of constructing the estimates of the shock.
The Australian, Canadian, and New Zealand monetary policy frameworks and experiences from the late eighties to the mid-1990s are compared in Debelle (1996) and (for the last two countries) Ammer and Freeman (1995) and Mishkin and Posen (1997).
For a summary of the RBA’s approach to inflation targeting, see “Monetary Policy and Inflation Targeting, Reserve Bank of Australia Bulletin, October 1997, pp. 14-19. For details on RBA operating procedures, see “The Reserve Bank’s Domestic Money Market Operations,” Reserve Bank of Australia Bulletin, December 1990, pp. 8-15.
See Bonato, St. Clair and Winkelmann and references therein.
For a discussion of monetary policy operating procedures before and after the switch to overnight interest rate targets, see Noël (1995), Clinton (1991), Kasman (1992), Gonzalez-Hermosillo and Ito (1997) and, for further references, Bank of Canada (1996a,b).
Generally, these are closing rates on the day on which the policy change was perceived by financial markets, minus closing rates on the previous day. In some cases in which there were major news after market closing on the previous day but prior to market opening on the day of the policy news, opening rates on the day of the policy news were used if available.
While there was no formal announcement of the overnight target until February 1996 (see Bank of Canada Review, Summer 1996, p. 21), shifts in the overnight band were “communicated to the market as quickly and clearly as possible”, through money market operations at the new level of interest rates, since about the Fall of 1994. However, “initially, a change in the bank was signaled … only when overnight rates threatened to trade outside the boundaries of the new band.” Noël (1995), p. 99-100. This may explain why it took until September 1994 for the Toronto Financial Post to pick up the changes.
For the period 1990-March 1998, this event-set is identical to the one described in Bonato, St. Clair and Winkelmann except that two “technical” RBNZ announcements (September 3 and 30, 1992), of which I found no mention in the press, were excluded. For the period March 1998-February 1999, I added all RBNZ announcements of the type compiled by Bonato, St. Clair and Winkelmann for the preceding period, i.e. comments on monetary conditions. For March 1999 until January 2000 all official cash rate (OCR) reviews were added that either changed the level of the OCR or went along with a comment on monetary conditions and the likelihood of future changes in the OCR.
In the words of Reserve Bank Monetary Policy Implementation Manager Michael Reddell, in a March 30, 1998 speech: “Both interest rates and the exchange rate influence inflation. Monetary policy can alter these two in combination, but whether one goes up and the other goes down, or vice versa, is beyond the control of the Reserve Bank. Rather, it is the result of trading in the financial markets, reflecting decisions taken by many thousands of people, both here and abroad.” Nevertheless, there were a few occasions when the authorities tried to separately indicate “appropriate” levels for the exchange rate and market interest rates, or at least were interpreted as doing that by the markets. However, these attempts were rare and, to my knowledge, never successful. An example is the December 17, 1996 presentation of the Bank’s monetary policy statement, whose main purpose appears to have been to endorse somewhat easier monetary conditions that had evolved over the preceding months, but which in addition mentioned specific “preferred” exchange rate and interest rate levels. “At the presentation of the bank’s six-monthly monetary policy statement, the governor, Dr. Don Brash, endorsed the recent market-led easing of monetary conditions but said a combination of the 90-day yield at 8.5 percent and the trade weighted exchange rate index at 66.5 would be consistent with overall conditions. With the 90-day yield at 7.88 percent and the index at 67.4, that pointed to a wish for higher interest rates and a lower dollar. But dealers said that higher interest rates meant a higher kiwi, so the kiwi’s value was sharply boosted.”
See Australian Financial Review, January 9, 1992. The effect of the intervention on the $A closing rate seems to have been moderate. The AFR reports a decline of the $A from US 75.9 to US75.5c in reaction to a 100 basis point easing of the cash rate target in the morning. Intervention briefly “helped hoist [the SA] to about US76c”, but “the dollar later drifted back to a close of US75. 7c.” It makes little difference to our results whether the initial depreciation of 0.4 cents of the depreciation of 0.2 cent over the whole day is used.
In terms of the “exogeneity classification” of Tables 1–3, A is the union of sets 1a, 1b, 2 and 3 (the full set); B is the union of sets 1a, 1b and 2; C is the union of sets 1a and 1b, and D is just set 1a.
This statement is based on the rule that, for reasons of precision, one should use the OLS estimates as long as the null hypothesis of no misspecification cannot be rejected based on the comparison of the IV and OLS results (i.e. using a Hausman test). In the above, the null is rejected only in the regressions for New Zealand (at the 5 percent level).
More precisely, a Chow test for structural breaks did not reject the null hypothesis of no structural break between the Australian and Canadian subsamples and a union of sets C for both countries (p = 0.85). Similarly, one cannot reject the null hypothesis of no structural break between the Australian, Canadian, and New Zealand subsamples and a union of sets C for Australia and Canada and set D for New Zealand (at high p-values).
In the regressions shown in Table 5, one additional observation—the easing of monetary policy on October 31, 1995 prompted by the favorable outcome of the Quebec referendum—had to be excluded for Canada. When using the change in the three month interest rate as a policy measure, it is possible to discriminate between the effect of the referendum and the effect of the policy action because the immediate post-referendum interest rate is quoted in the newspapers. This, unfortunately, is not the case for the two longer rates.
To economize on presentation, only either OLS or IV results are shown, depending on whether the Hausman test rejected or not (see line "Hausman p”). The commodity price data consists of changes in the daily commodity futures price index compiled by The Bridge/Commodities Research Bureau and its subcomponents for grains, livestock and meats, and precious metals (Source: Datastream; see http://www.crbindex.com on information about how this index is compiled).
For New Zealand, Set C contains a number of very noisy data points, and the relatively small sample sizes in the exercise that follows precludes the use of IV to deal with this noise. Comparing the OLS coefficients on the three-month interest rates across the three countries in Table 4, along with the Chow test results mentioned earlier, suggests that Sets C for Australia and Canada and Set D for New Zealand are good choices for the purposes of pooling.
The Chow tests mostly refer to testing for a break between the particular subsample associated with each column and the whole sample (including outliers in the case of the left set of columns, and excluding them in the case of the right set of columns). The only exception is the Ch