Paris Saclay Seminar

Dornbusch’s overshooting hypothesis and the systematic component of domestic and foreign monetary policy : new evidence from small open-economy SVARs

Nicolas Groshenny (Le Mans University)

Dec 01, 2022, 12:15

CEPS, University of Evry-Val-d'Essonne, Room Malinvaud



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.

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CEPS Organizers :
Morgan Patty (ENS Paris-Saclay)
• Margarita López-Forero (University of Evry-Val d’Essonne)

CEPS Administrative Support :
Christelle Lebosse
Oscar Javier Valencia Peña