The exchange rate and the monetary transmission mechanism in Germany

For the conduct of monetary policy under floating exchange rates it is impo rtant to understand the role of the exchange rate in the monetary transmiss ion mechanism (MTM). The timing and the magnitude of the effects of a chang e in the exchange rate on output and inflation may be quite different from traditional interest rate channels, thereby affecting optimal policy. In th is paper we examine the exchange rate channel in the MTM in Germany by esti mating an identified VAR model. Two features of the results are highlighted . The effect of a policy shock on the exchange rate accelerates the pass-th rough of policy into prices and leads to a different response of the variou s components of GDP. We then show that these qualitative effects can be dup licated in a general equilibrium model for a semi-small open economy with s ticky prices and wages that is calibrated to capture the main features of t he German economy.