Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach

Past empirical research on the effects of monetary policy in closed and ope n economies found evidence of several anomalies, such as the 'liquidity', ' price','exchange rate' and 'forward discount bias' puzzles. In this paper, we develop an approach that provides a solution to these empirical anomalie s in an open economy setup. We use a 'structural VAR' approach with non-rec ursive contemporaneous restrictions and we identify monetary policy shocks by modeling the reaction function of the monetary authorities and the struc ture of the economy. Our empirical findings are that effects of non-US G-7 monetary policy shocks on exchange rates and other macroeconomic variables are consistent with the predictions of a broad set of theoretical models. T he evidence is consistent with significant, but transitory, real effects of monetary shocks. The 'price' puzzle is addressed and there is little evide nce of open economy anomalies. Specifically, initially the exchange rate ap preciates in response to a monetary contraction; but after a few months, th e exchange rate depreciates over time in accordance with the uncovered inte rest parity condition. Overall, our identification scheme gives results tha t contribute to resolve the empirical anomalies about the effects of moneta ry policy shocks found in the literature. (C) 2000 Elsevier Science B.V. Al l rights reserved. JEL classification: C32; E52; F31; F42.