Monetary news in the United States and business cycles in emerging economies

This paper identifies anticipated (news) and unanticipated (surprise) shocks to the U.S. Fed 
Funds rate using Fed Funds Futures contracts, and assesses their propagation to emerging economies. Anticipated shocks are identified as the expected change in the Fed Funds rate orthogonal to expected U.S. business cycle conditions while unanticipated shocks are the one-step 
ahead forecast error. Anticipation accounts for 80 percent of quarterly Fed Funds fluctuations 
and explains 47 percent of the narrative series of monetary policy shocks. To identify the effects of both shocks, I estimate a Panel VAR using a sample of emerging economies. An anticipated (unanticipated) 25 basis points contractionary U.S. interest rate shock induces a fall of 
0.5 percent in GDP from its trend one quarter before (after) the shock materializes. This effect 
is coupled with a depreciation of the exchange rate, an increase in sovereign spreads, and a 
decline in external credit. Accounting for anticipation almost doubles the role of U.S. interest 
rate shocks as a driver of business cycles in emerging economies, explaining almost 20 percent 
of output fluctuations.

Monetary news, U.S. interest rate and business cycles in emerging economies

Monetary policy increasingly relies on steering market expectations about future policy. This paper identifies a monetary policy news shock based on a VAR model. A monetary news shock is equivalent to new information about the Fed's future monetary policy becoming available today. One example of a monetary news shock is a Forward Guidance announcement, where the Fed unveils its prospectively (binding) monetary policy, today. In this paper, we study the spillover effects of news shocks. We estimate the response of the euro area to an expected future policy tightening of the Fed. The U.S. news shock improves sentiment and business cycle expectations in the euro area, which is consistent with the notion of the Fed revealing favorable news by a tightening announcement. We also distinguish the news shock from a conventional U.S. policy surprise and find that they lead to diverging responses in the euro area.

https://www.econstor.eu/bitstream/10419/200688/1/32-2018_rudel.pdf

News shocks spillovers: How the euro area responds to expected Fed policy

When Credit Expansions Become Troublesome: The Story of Investor Sentiments

The Ghanaian Cedi has recently experienced persistent depreciation against its major trading partners. This paper investigates the contribution of inflation and monetary policy in this persistent depreciation. The paper makes use of the Autoregressive Distributed Lag (ARDL) and Bounds test of cointegration and the Toda and Yamamoto (1995) Augmented Granger Causality test to determine the long and short-run dynamics of the impact of monetary policy and inflation on exchange rates in Ghana, using data ranging from 1970 to 2017. The paper finds a short-run depreciation effect of contractionary monetary policy on the exchange rate, reflecting the exchange rate puzzle. The long-run results however show an appreciating effect. Inflation is also found to depreciate the currency both in the short and long-run. The causality tests also reveal a bi-directional relationship between the exchange rate and the inflation rate, while a unidirectional causal relationship exists between monetary policy and the exchange rate. The paper recommends that inflation stabilization policies should be prioritized in Ghana, as a means to curb the rising exchange rates. Improvement in terms of trade through export value promotion should also be given the needed attention as this is found to appreciate the currency in the long-run.

	 

	Key words: Exchange rate, inflation, money supply, Autoregressive Distributed Lag (ARDL), cointegration, Ghana.

/pdf/the-effect-of-monetary-policy-and-inflation-on-the-exchange-23gz407aiw.pdf

The effect of monetary policy and inflation on the exchange rate: A case study of Ghana

Recursive vector autoregression (VAR) analysis suggests that the nominal exchange rate tends to depreciate after a contractionary monetary policy shock in most developing countries, a puzzle for virtually all open-economy macroeconomic models. Using a structural VAR approach, we document that when the U.S. economic outlook worsens developing countries' exchange rates signicantly depreciate and their policy-controlled interest rates increase. We show that commonly used recursive VAR schemes inevitably confound these correlations for the monetary policy innovation. In our econometric framework, we identify the spillover effects of future U.S. business cycles as the innovations that best explain future movements in the Federal Funds rate over an horizon of two years. When the monetary policy shock is then cleansed of these variations, the exchange rate response puzzle disappears. We conclude by showing that a standard small open economy model with news about future fundamentals in a large economy is consistent with all the empirical findings of this paper.

Revisiting the Exchange Rate Response to Monetary Policy Innovations: The Role of Spillovers of U.S. News Shocks

Using data from the Survey of Professional Forecasters, we observe that a large fraction of analysts' expectations about future economic growth is not due to technology or other shocks to fundamentals measured by the business cycle literature. We find that these unexplained changes in forecast revisions predict significant boom-bust dynamics in the key macroeconomic aggregates. We offer a novel theory where boom-bust dynamics stem from expectation shocks orthogonal to fundamentals. 

Expectation-driven boom-bust cycles

We find that variation in expected U.S. productivity explains more than half of G6 exchange rate fluctuations vis-a-vis the USD. Both correctly-anticipated changes in productivity and expectational “noise”, which influences expected productivity but never its realization, play an important role in driving exchange rates. Together, these disturbances account for many unconditional exchange rate patterns, including predictable excess returns, low Backus-Smith correlations, and excess volatility. Our findings suggest these famous puzzles share a common empirical origin, one that is very much connected to (expected) fundamentals. JEL Codes: D8, F3, G1

Exchange Rate Disconnect Revisited

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Revisiting the Exchange Rate Response to Monetary Policy Innovations: The Role of Spillovers of U.S. News Shocks

Expectation-driven boom-bust cycles

Exchange Rate Disconnect Revisited