Melecky, Martin (2007): A structural investigation of third-currency shocks to bilateral exchange rates.
This is the latest version of this item.
Download (446kB) | Preview
An exchange rate between two currencies can be materially affected by shocks emerging from a third country. A US demand shock, for example, can affect the exchange rate between the euro and the yen. Since positive US demand shocks have a greater positive impact on Japanese interest rates than on eurozone rates, the yen appreciates against the euro in response. Using quarterly data on the U.S., the euro area and Japan from 1981 to 2006, this paper shows that the third-currency effects are significant even when exchange rates evolve according to uncovered interest parity. This is because interest rates are typically set in response to output and inflation, which are in turn influenced by other exchange rates. More importantly, third-currency effects are also transmitted to the actual exchange rate through the expected future exchange rate which is, in a multi-country setup, influenced by third-countries' fundamentals and shocks. Third-currency effects have a stronger impact on the currency of a relatively more open economy. The analysis implies that small open economies should avoid strict forms of bilateral exchange rate targeting, since higher trade and financial openness work as a force intrinsically amplifying currency fluctuations.
|Item Type:||MPRA Paper|
|Institution:||Department of Economics, Technical University of Ostrava|
|Original Title:||A structural investigation of third-currency shocks to bilateral exchange rates|
|Keywords:||bilateral exchange rates; third-currency shocks; New Keynesian policy model; three-country system; US dollar; euro; Japanese yen|
|Subjects:||F - International Economics > F3 - International Finance > F31 - Foreign Exchange
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration
|Depositing User:||Martin Melecky|
|Date Deposited:||11. Mar 2008 02:58|
|Last Modified:||14. Feb 2013 11:33|
 Adolfson, M., Laseen, S. ,Linde, J., Villani, M. (2005). Empirical Properties of Closed and Open Economy DSGE Models of the Euro Area. Manuscript, Sveriges Riksbank.  An, S., Schorfheide, F. (2005). Bayesian Analysis of DSGE Models. CEPR Discussion Paper 5207.  Brandt, M.W., Chochrane, J.H., Santa-Clara, P. (2006). International Risk Sharing is Better Than You Think, or Exchange Rates are Too Smooth. Journal of Monetary Economics 4, vol. 53, 671-698.  Buncic, D., Melecky, M. (forthcoming). An Estimated New Keynesian Policy Model for Australia. Economic Record.  Cheung, Y., Chinn, M.D., Pascual, A.G. (2005). Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive? Journal of International Money and Finance 7, Vol. 24, 1150-1175.  Chinn, M.D., Meredith, G. (2004). Monetary Policy and Long-Horizon Uncovered In- terest Parity. IMF Sta¤ Papers 51, 409�430.  Cho, S., Moreno, A. (2006). A Small-Sample Study of the New-Keynesian Macro Model. Journal of Money, Credit and Banking 38, 1461�1481.  Christiano, L. J., Eichenbaum, M., Evans, C. (2001). Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy. Working Paper 01-07, Federal Reserve Bank of Cleveland.  Clarida, R., Gali, J., Gertler, M. (2001). Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach. American Economic Review 91, 248�252.  Clarida, R., Gali, J., Gertler, M. (2002). A Simple Framework for International Monetary Policy Analysis. Journal of Monetary Economics 49, 879�904.  Del Negro, M., Schorfheide, F., Smets, F.,Wouters, R. (2005). On the �t and Forecasting Performance of New-keynesian Models. ECB Working Paper 491. Frankfurt am Main.  Dennis, R., Leitemo, K., Soderstrom, U. (2007). Monetary policy in a small open econ- omy with a preference for robustness. CEPR Discussion Paper 6067.  Engel, C., West, K.D. (2005). Exchange Rate and Fundamentals. Journal of Political Economy 3, vol. 113, 485-517.  Fagan, G., Henry, J., Mestre, R. (2001). An Area-Wide Model (AWM) for the Euro Area. ECB Working Paper 42. Frankfurt am Main.  Ferreiraa, A.L., León-Ledesma, M.A. (2007). Does the Real Interest Parity Hypothesis Hold? Evidence for Developed and Emerging Markets. Journal of International Money and Finance 3, Vol. 26, 364-382.  Giordani, P. (2004). Evaluating New-KeynesanModels of a Small Open Economy. Oxford Bulletin of Economics and Statistics 66, 713�733.  Hodrick, R. Vassalou, M. (2002). Do we need multi-country models to explain exchange rate and interest rate and bond return dynamics? Journal of Economic Dynamics & Control 26, 1275�1299.  Justiniano, A., Preston, B. (2004). Small Open Economy DSGE Models: Speci�fication, Estimation and Model Fit. Manuscript, Columbia University.  Linde, J. (2005). Estimating New-Keynesian Phillips Curves: A Full Information Maxi- mum Likelihood Approach. Journal of Monetary Economics 52, 1135�1149.  Kingston, G., Melecky, M. (2007). Currency Preferences and the Australian Dollar. Journal of International Money and Finance 26(3), 454-467.  Lubik, T.A. (2005). A Simple, Structural, and EmpiricalModel of the Antipodean Trans- mission Mechanism. Manuscript, Johns Hopkins University.  Lubik, T.A., Schorfheide F. (2007). Do Central Banks Respond to Exchange Rate Move- ments? A Structural Investigation. Journal of Monetary Economics 54(4), 1069-1087.  MacDonald, R., Marsh, I.W., (1999). Currency spillovers and tri-polarity: a simultaneous model of the US dollar, German mark and Japanese yen. Journal of International Money and Finance 23, 99�111.  Mark, N.C., Moh, Y.K. (2001). What do Interest-Rate Di¤erentials Tell us about the Exchange Rate? Manuscript, Ohio State University.  McCallum, B.T., Nelson, E. (2001). Monetary Policy for an Open Economy: An Alter- native Framework with Optimizing Agents and Sticky Prices. CEPR Discussion Paper 2756.  Monacelli, T. (2005). Monetary Policy in a Low Pass-Through Environment. Journal of Money, Credit and Banking 37, 1047�1066.  Nucci, F. (2003). Cross-Currency, Cross-Maturity Forward Exchange Premiums as Predictors of Spot Rate Changes: Theory and Evidence. Journal of Banking and Finance 27, 183-200.  Rudd, J., Whelan, K. (2005). New Tests of the New-Keynesian Phillips Curve. Journal of Monetary Economics 52, 1167�1181.  Sims, C.A. (2002). Solving Linear Rational Expectations Models. Computational Economics 20, 1�20.  Smets, F., Wouters, R. (2003). An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area. Journal of the European Economic Association 1, 1123�1175.  Svensson, L.E.O. (2000). Open-Economy In�ation Targeting. Journal of International Economics 50, 155�183.
Available Versions of this Item
A structural investigation of third-currency shocks to bilateral exchange rates. (deposited 02. Oct 2007)
A structural investigation of third-currency shocks to bilateral exchange rates. (deposited 01. Mar 2008 06:33)
- A structural investigation of third-currency shocks to bilateral exchange rates. (deposited 11. Mar 2008 02:58) [Currently Displayed]
- A structural investigation of third-currency shocks to bilateral exchange rates. (deposited 01. Mar 2008 06:33)