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

fluctuations due to monetary policy shocks range between 5 and 60 percent,
see Clarida and Gali (1994), Eichenbaum and Evans (1995), Rogers (1999),
Faust and Rogers (2000) and Kim and Roubini (2000).

Recently, this conventional view has come under attack. Most notably,
Faust and Rogers (2003) argue, that one needs to “relax dubious identifying
assumptions stemming from e.g. recursive identification and impose at most
rather mild sign restrictions or shape restrictions a priori in order to draw
robust conclusions about the impact of monetary policy shocks on exchange
rates. They find that no robust conclusions can be drawn regarding the
timing of the peak response of the exchange rate, that there is robust evidence
in favor of large deviations from UIP due to monetary policy shocks (see
figure 2) and that monetary policy shocks may or may not be a cause of
exchange rate volatility.

Indeed, we shall see that the identification strategies proposed by Eichen-
baum and Evans or by Grilli and Roubini lead to significant ”price puzzles”
when applied to an updated data set, furthermore calling their original results
into questions.

This paper reexamines these issues. We identify monetary policy shocks,
using the approach of Uhlig (2005) of imposing sign restrictions on impulse
response functions. In particular, we assume that domestic contractionary
monetary policy shocks do not lead to decreases in domestic short-term in-
terest rates, increases in domestic prices and increases in domestic monetary
aggregates. Hence, we match the conventional wisdom and avoid the price as
well as the liquidity puzzle by construction. Crucially, we do not impose any
restrictions on the exchange rate to leave the central question as open as pos-
sible. We argue that these sign restrictions are plausible because they most
directly reflect what economists have in mind (or how economists informally
evaluate empirical results) when thinking about monetary policy shocks.

We view this as the continued pursuit of the agenda of Sims (1980).

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