COVID-19 and Exchange Rates: Spillover Effects of U.S. Monetary Policy
One sentence summary: The spillover effects of U.S. monetary policy have been effective only for certain countries that can be explained by the disease outbreak channel.
The corresponding academic paper by Hakan Yilmazkuday has been accepted for publication at Atlantic Economic Journal.
The working paper version is available here.
Abstract
This paper investigates the spillover effects of U.S. monetary policy on exchange rates of 11 emerging markets and 12 advanced economies during the pre-COVID-19 versus COVID-19 periods. The investigation is achieved by a structural vector autoregression model, where year-on-year changes in weekly measures of economic activity, exchange rates and policy rates are used. The empirical results suggest evidence for the spillover effects of U.S. monetary policy for several countries during the pre-COVID-19 period, whereas they have been effective only for certain countries during the COVID-19 period that can be explained by the disease outbreak channel. Important policy implications follow.
Abstract
This paper investigates the spillover effects of U.S. monetary policy on exchange rates of 11 emerging markets and 12 advanced economies during the pre-COVID-19 versus COVID-19 periods. The investigation is achieved by a structural vector autoregression model, where year-on-year changes in weekly measures of economic activity, exchange rates and policy rates are used. The empirical results suggest evidence for the spillover effects of U.S. monetary policy for several countries during the pre-COVID-19 period, whereas they have been effective only for certain countries during the COVID-19 period that can be explained by the disease outbreak channel. Important policy implications follow.
The Coronavirus Disease 2019 (COVID-19) has reduced economic activity in an unprecedented way. This reduction has resulted in extraordinary unemployment levels around the world. Accordingly, several central banks, including the U.S. Federal Reserve System, have reacted to the economic developments due to COVID-19 by reducing their policy rates.
This paper investigates the spillover effects of U.S. monetary policy on exchange rates during the pre-COVID-19 versus COVID-19 periods. The main objective is to investigate whether these spillover effects have been effective during the COVID-19 period. Country-specific analyses are conducted for 11 emerging markets and 12 advanced economies, where monetary policies of these countries are also controlled for. The formal investigation is by a structural vector autoregression (SVAR) model, where year-on-year growth rates of weekly measures of economic activity, exchange rates, and policy rates are used during the pre-COVID-19 versus COVID-19 periods.
The spillover effects of U.S. monetary policy are investigated by accepting the U.S. economy as an exogenous block to be used in the SVAR estimation of each country. We focus on the cumulative impulse response of exchange rates (constructed as appreciation of currencies) to a negative shock on the (shadow) federal funds rate. We also investigate the contribution of (shadow) federal funds rate to the exchange rate volatility of domestic currencies based on the forecast error variance decomposition.
The empirical results suggest that there is evidence for the spillover effects of U.S. monetary policy for almost all countries during the during the pre-COVID-19 period, whereas they have been effective for only certain countries during the COVID-19 period. When we further investigate the reasons behind the heterogeneity across countries, we show that only the exchange rates of countries that were successful in fighting against COVID-19 were subject to the spillover effects of U.S. monetary policy during the COVID-19 period
The corresponding academic paper by Hakan Yilmazkuday has been accepted for publication at Atlantic Economic Journal.
The working paper version is available here.