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Monetary Policy Shocks and Exchange Rate Dynamics in Small Open Economies

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dc.contributor.authorTerrell, M.
dc.contributor.authorHaque, Q.
dc.contributor.authorCross, J.L.
dc.contributor.authorDoko Tchatoka, F.
dc.date.issued2026
dc.descriptionOnlinePubl
dc.description.abstractThis paper investigates whether the effects of monetary policy shocks on real exchange rates have changed over time and, if so, whether these changes stem from shifts in transmission mechanisms or from variation in the volatility of the shocks themselves. Using a time-varying parameter VAR with stochastic volatility for six small open economies, we first show that a constant-parameter VAR with stochastic volatility provides the best fit to the data in all six cases. We then employ an identification strategy that combines short- and long-run restrictions to isolate monetary policy shocks, and we evaluate its robustness using high-frequency monetary policy surprises as external instruments. Our results support Dornbusch's overshooting hypothesis in most countries. However, uncovered interest parity is frequently violated, as foreign excess returns diverge from zero following monetary policy shocks. Finally, we document a substantial decline in the volatility of monetary policy shocks since the 1990s, leading to a reduced contribution to exchange rate and macroeconomic fluctuations.
dc.description.statementofresponsibilityMadison Terrell, Qazi Haque, Jamie L. Cross, Firmin Doko Tchatoka
dc.identifier.citationJournal of Applied Economics, 2026; 1-12
dc.identifier.doi10.1002/jae.70051
dc.identifier.issn1514-0326
dc.identifier.issn1667-6726
dc.identifier.orcidHaque, Q. [0000-0003-0694-4443]
dc.identifier.orcidDoko Tchatoka, F. [0000-0003-1876-0633]
dc.identifier.urihttps://hdl.handle.net/2440/150120
dc.language.isoen
dc.publisherTaylor & Francis Group
dc.relation.granthttp://purl.org/au-research/grants/arc/DP200101498
dc.relation.granthttp://purl.org/au-research/grants/arc/DP210103094
dc.relation.granthttp://purl.org/au-research/grants/arc/DP240100970
dc.rights© 2026 The Author(s). Journal of Applied Econometrics published by John Wiley & Sons Ltd. This is an open access article under the terms of the Creative Commons Attribution License
dc.source.urihttps://doi.org/10.1002/jae.70051
dc.subjectExchange rate
dc.subjectMonetary policy shocks
dc.subjectTVP-VARs
dc.subjectUIP
dc.titleMonetary Policy Shocks and Exchange Rate Dynamics in Small Open Economies
dc.typeJournal article
pubs.publication-statusPublished

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