New Evidence on the Puzzles. Results from Agnostic Identification on Monetary Policy and Exchange Rates.

5 Conclusions

This paper has estimated the effects of monetary policy shocks on the US-
German, the US-UK and the US-Japanese bilateral exchange rates by ap-
plying an agnostic identification method recently proposed by Uhlig (2005).
A priori theorizing has been made explicit by imposing sign restrictions on
the impulse responses of selected variables for a certain period following the
shock. We view this identification strategy as a consequent pursuit of the
agenda put forth by Sims (1980) of avoiding incredible identifying restric-
tions. In particular, we impose no or only weak restrictions on the exchange
rate to leave the key questions as open as possible.

We have followed conventional wisdom and have assumed that domestic
contractionary monetary policy shocks do not lead to decreases in domes-
tic short-term interest rates, increases in domestic prices and increases in
domestic monetary measures.

It has turned out that the evidence on the delayed overshooting, the
forward discount and the exchange rate puzzles remain, but that their quan-
titative properties change. Applying our identification scheme to a bench-
mark VAR we have found that with 2/3 probability the US-German and the
US-UK exchange rates appreciate for about 9 months and then depreciate.
Only the US-Japanese exchange rate shows a delayed overshooting up to 24
months.

Regarding the forward discount puzzle, we evaluate the risk inherent in
exploiting the forward discount premium by calculating the Sharpe ratio for a
Bayesian investor, and find considerably higher but not dramatically different
from those found on asset markets. We do find a robust exchange rate puzzle,
in the sense that there is a rather a stable and inconclusive pattern across
several countries and specifications, in contrast to the results from standard
identification procedures. Quantitatively, monetary policy shocks seem to

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