Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/266032 
Year of Publication: 
2022
Series/Report no.: 
MAGKS Joint Discussion Paper Series in Economics No. 34-2022
Publisher: 
Philipps-University Marburg, School of Business and Economics, Marburg
Abstract: 
The open economy New Keynesian model with flexible exchange rates postulates that the real exchange rate appreciates in response to an asymmetric negative demand shock in a zero lower bound (ZLB) scenario and exacerbates the adverse macroeconomic effects. However, when monetary policy is able to accommodate the adverse effects of the negative demand shock via unconventional measures, the model can generate a real depreciation at the ZLB. This paper examines these counteracting exchange rate channels empirically. We estimate the effect of a negative asymmetric demand shock on the real exchange rate and inflation expectations as well as output and prices by employing state-dependent and sign-restricted local projection methods for the euro area vis-Ã -vis the United States, Canada, and Japan. We find that the real exchange rate depreciates when interest rates are not at the ZLB but also when they are. Furthermore, our empirical results show that the real exchange rate can absor considerable variations in output, confirming its shock-absorbing capacity before but also during the ZLB episode. The stabilizing role of the exchange rate is accompanied by a significant expansion of the ECBs balance sheet in the ZLB period, while it remained unaffected in the pre-ZLB period. Overall, our empirical results favor the open economy New Keynesian model with unconventional measures when interest rates are at the ZLB.
Subjects: 
Zero Lower Bound
Exchange Rate
Local Projections
State-dependent Effects
JEL: 
F31
E31
E37
C54
Document Type: 
Working Paper

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