Policy Words and Policy Deeds: The ECB and the Euro

Bohl MT, Siklos PL


Abstract
This paper examines the role of the European Central Bank (ECB) communication activities on daily eurodollar exchange rate and interest rates. We estimate the relationship between monetary policy and the exchange rate using a technique that explicitly recognizes the joint determination of both the levels and volatilities of these variables. We also consider more traditional estimation strategies as a test of the robustness of our main results. We introduce a new indicator of ECB communication policies that focuses on what the ECB says about the future economic outlook for the euro area along five different economic dimensions. The impact of the ECB communication policies is more apparent in the time-series framework than in the heteroskedasticity estimator approach. Time-series estimates reveal that interest rate changes generally have a much larger impact on exchange rate movements, and their volatility, than do ECB verbal pronouncements. Previous studies that conclude that news effects are significant at the daily frequency may have reached such a conclusion because the measurement of news was too highly aggregated. The endogeneity of the exchange rate-interest rate relationship is more apparent when the proxy for monetary policy is the euro area-US differential than when any other proxy for monetary policy is employed. Copyright © 2007 John Wiley & Sons, Ltd.

Keywords
Central bank communication; eurodollar exchange rate; European Central Bank; interest rates; heteroskedasticity estimator approach



Publication type
Research article (journal)

Peer reviewed
Yes

Publication status
Published

Year
2008

Journal
International Journal of Finance & Economics

Volume
13

Issue
3

Start page
247

End page
265

Language
English

ISSN
1099-1158

DOI