Exchange rate movements in the presence of the zero lower bound

  • Published March 24, 2017
  • Author(s)
    Jens Klose
  • DOI
    http://dx.doi.org/10.21511/bbs.12(1).2017.10
  • Article Info
    Volume 12 2017, Issue #1, pp. 82-87
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Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License

Exchange rates are expected to adjust according to the stance of monetary policies, which are in normal times differences in interest rates set by the central banks. This interest rate parity does, however, no longer hold if central banks approach the zero lower bound on interest rates and switch to measures of quantitative easing. Therefore, the author estimates exchange rate changes based on the different stance of the monetary base, which is an indicator of differing monetary policies in the countries. The results reveal that indeed exchange rates movements in the Dollar-Euro-Rate can be explained by differences in the monetary base, since the zero lower bound has become binding. However, the influence depends crucially on whether the monetary base is increased or decreased and whether the other central bank is also expanding or reducing its balance sheet at the same time.

Keywords: monetary base, exchange rate, Fed, ECB.
JEL Classification: E52, E58, F42

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  • References
    9
  • Tables
    4
  • Figures
    2
    • Fig. 1. Fed funds rate for the Fed, main refinancing rate for the ECB
    • Fig. 2. Monetary base of the Fed and the ECB
    • Table 1. Common response
    • Table 2. Central bank specific response
    • Table 3. State numbers
    • Table 4. State specific response
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