Monetary policy and exchange rate anomalies in set-identified SVARs: Revisited

Abstract

Set-identified vector autoregressions typically document violations of uncovered interest rate parity (forward discount puzzle) and gradual appreciation–depreciation cycles of exchange rates (delayed overshooting puzzle) following contractionary monetary policy shocks. We revisit both anomalies in a framework similar to Kim et al. (2017, JPE). We complement their identifying restrictions on how monetary policy affects the economy with restrictions on (i) how monetary policy reacts to the economy and (ii) historical monetary policy innovations. In this hybrid identification, no major forward discount premia emerge. Once we additionally impose that monetary policy propagates through domestic financial conditions, exchange rates also overshoot with less delay.