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Monetary Policy and Exchange Rates: A Balanced Two-Country Cointegrated VAR Model Approach

Heinlein, Reinhold, Krolzig, Hans-Martin (2019) Monetary Policy and Exchange Rates: A Balanced Two-Country Cointegrated VAR Model Approach. Macroeconomic Dynamics, 23 (5). pp. 1838-1874. ISSN 1365-1005. (doi:10.1017/S1365100517000475) (KAR id:62158)


We study the exchange rate effects of monetary policy in a balanced macroeconometric two-country model for the US and UK. In contrast to the empirical literature, which consistently treats the domestic and foreign countries unequally in the modelling process, we consider full model feedback, allowing for a thorough analysis of the system dynamics. The problem of model dimensionality is tackled by invoking the approach by Aoki (1981). Assuming country symmetry in the long-run allows to decouple the two-country macro dynamics of country averages and differences such that the cointegration analysis can be applied to smaller systems. Secondly the econometric modelling is general-tospecific, a graph-theoretic approach for the contemporaneous effects combined with automatic general-to-specific model selection. We find delayed overshooting of the exchange rate in the case of a Bank of England monetary shock but instantaneous response to a Fed shock. Altogether the response is more pronounced in the former case.

Item Type: Article
DOI/Identification number: 10.1017/S1365100517000475
Uncontrolled keywords: Two-country model; Cointegration; Monetary Policy; Exchange Rates
Subjects: H Social Sciences > HB Economic Theory
Divisions: Divisions > Division of Human and Social Sciences > School of Economics
Depositing User: Hans-Martin Krolzig
Date Deposited: 28 Jun 2017 09:05 UTC
Last Modified: 04 Mar 2024 15:16 UTC
Resource URI: (The current URI for this page, for reference purposes)

University of Kent Author Information

Krolzig, Hans-Martin.

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