Exchange rates, central bank news and the zero lower bound*

ABSTRACT

The zero lower bound (ZLB) may restrict the responsiveness of exchange rates to news. A proxy for central bank communication is added as a determinant in a model of exchange rate movements. Two reserve currencies, the British pound and euro, and two currencies of small open economies, the Canadian dollar and Swedish krona, are examined. Reserve currencies are more vulnerable to the ZLB constraint, while the currencies of small open economies become more responsive to foreign central bank announcements. Certain unconventional monetary policy announcements were found to significantly impact exchange rates at the ZLB.

KEYWORDS:

• Zero lower bound
• foreign exchange rates
• unconventional monetary policy
• central bank communication

JEL CLASSIFICATION:

• E52
• E58
• F31

Acknowledgement

Siklos is grateful to the BIS and the Hoover Institution at Stanford University where parts of this article were written and to CIGI for financing and supporting this research.

Disclosure statement

No potential conflict of interest was reported by the authors.

Supplemental Material

Supplemental data for this article can be accessed here.

Notes

¹ A risk premium term could be added; for simplicity this is set to zero.

² Defined as $s_t+p_t^{\ast }-p_t$, where $p$ is the (log) of the price levels.

³ The derivation (not shown) requires that exchange rates satisfy some steady state in equilibrium.

⁴ The term effective zero lower bound (ZLB) refers to a boundary that was, at some point, deemed the lowest policy interest rate that the domestic central bank was willing to tolerate. Several years into the crisis, several central banks have acknowledged that the effective ZLB may be below zero and some have even introduced negative rates.

⁵ The US policy interest rate was constrained by the ZLB from December 2008 to the end of the sample period.

⁶ Dates are provided in the online appendix.

⁷ The results can be found in an online appendix.

Additional information

Funding

Siklos is grateful to CIGI for financing and supporting this research.