The effects of conventional and unconventional monetary policy on exchange rates

What are the effects of monetary policy on exchange rates? And have unconventional monetary policies changed the way monetary policy is transmitted to international financial markets? According to conventional wisdom, expansionary monetary policy shocks in a country lead to that country's currency depreciation. We revisit the conventional wisdom during both conventional and unconventional monetary policy periods in the US by using a novel identification procedure that defines monetary policy shocks as changes in the whole yield curve due to unanticipated monetary policy moves and allows monetary policy shocks to differ depending on how they affect agents' expectations about the future path of interest rates as well as their perceived effects on the riskiness/uncertainty in the economy. Our empirical results show that: (i) a monetary policy easing leads to a depreciation of the country's spot nominal exchange rate in both conventional and unconventional periods; (ii) however, there is substantial heterogeneity in monetary policy shocks over time and their effects depend on the way they affect agents' expectations; (iii) we find favorable evidence to Dornbusch's (1976) overshooting hypothesis; (iv) changes in expected real interest rates play an important role in the transmission of monetary policy shocks.Supported by the Fundación BBVA scientific research grant (PR16_DAT_0043) on Analysis of Big Data in Economics and Empirical Applications and the Cerca Programme/Generalitat de Catalunya. We thank Charles Engel, Jordi Galí, Refet Gürkaynak, James Morley, Giovanni Ricco, Jonathan Wright, seminar participants at the 2018 ISoM conference, 2018 ASSA, UCL, Tor Vergata, Bank of Russia, the 2018 Royal Economic Society conference as well as Lukas Hoesch for excellent research assistance and Silvia Miranda-Agrippino for help with the UK data. We acknowledge financial support from the Spanish ministry of the Economy and Competitiveness through the Severo Ochoa Programme for Centers of Excellence in R&D (SEV-2015-0563) and grant ECO2015-68136-P