Monetary policy and exchange rates: further evidence using a new method for implementing sign restrictions

This paper estimates SVARs for four small and three large economies. Sign restrictions are used to identify all the shocks in the SVARs, while being agnostic about the sign of the response of the real exchange rate to a relative monetary policy shock. The large number of sets of impulse responses to be judged by sign restrictions for either retention or rejection is generated by a newly proposed method which utilizes instrumental variable estimation. The responses show an absence of an exchange rate puzzle in each economy. The peak appreciation following a contractionary monetary policy shock occurs with at most a one quarter delay in the small countries and, for the United States, on impact. For the Euro region and Japan, the peak appreciation is in the long run. There is considerable model uncertainty in the responses.