Does a Big Bazooka Matter? Central Bank Balance-Sheet Policies and Exchange Rates

Abstract

We estimate the effects of quantitative easing (QE) measures by the ECB and the Federal Reserve on the US dollar-euro exchange rate at frequencies and horizons relevant for policymakers. To do so, we derive a theoretically-consistent local projection regression equation from the standard asset pricing formulation of exchange rate determination. We then proxy unobserved QE shocks by future changes in the relative size of central banks' balance sheets, which we instrument with QE announcements in two-stage least squares regressions in order to account for their endogeneity. We find that QE measures have large and persistent effects on the exchange rate. For example, our estimates imply that the ECB's APP program which raised the ECB's balance sheet relative to that of the Federal Reserve by 35 percentage points between September 2014 and the end of 2016 depreciated the euro vis-á-vis the US dollar by 12%. Regarding transmission channels, we find that a relative QE shock that expands the ECB's balance sheet relative to that of the Federal Reserve depreciates the US dollareuro exchange rate by reducing euro-dollar short-term money market rate differentials, by widening the cross-currency basis and by eliciting adjustments in currency risk premia. Changes in the expectations about the future monetary policy stance, reflecting the "signalling" channel of QE, also contribute to the exchange rate response to QE shocks.

Monetary policy announcements and expectations: Evidence from german firms

“…Specifically, we exclude "no production" or similar answers which indicate that the question does not apply to the firm. Dates are an extended version of the list provided by Dedola et al (2018). We also show which round of the survey of professional forecasters (SPF) conducted by the ECB is associated with the events.…”

“…Our list of events largely follows Dedola et al (2018). before the press release to the median quote during the interval 14:00-14:15 after it.…”

“…5 Dedola et al (2018) analyze the impact of quantitative easing measures and hence consider only policies that affect the ECB's balance sheet. Our focus is broader, such that we include additional announcements like the first forward guidance communication or the announcement of the Outright Monetary Transactions (OMT).…”

Exchange Rate Pass-Through in the Euro Area and EU Countries

“…However, unlike standard monetary policy, they have direct implications for the expected supply of and demand for internationally traded bonds and, hence, for the level of the exchange rate that, all other things being equal, clears the resulting capital flows. Dedola et al (2018) document empirically the effectiveness of the ECB's non-standard monetary policies on the exchange rate and their transmission to prices and economic activity. They find that the response of exchange rates is due predominantly to risk premia and signalling, but with relatively muted effects on inflation and output.…”