Investigating the impact of monetary policy on foreign exchange market in Europe during COVID-19 pandemic

ABSTRACT

In this paper, we investigated how policy rate modifications – the main instrument used by central banks to provide liquidity during the current health crisis – influenced the evolution of the exchange rate, which is a key element within macro-stabilization policies. We documented that foreign exchange markets in European countries responded asymmetrically to monetary policy interventions devoted to the encouragement of spending and the stimulation of the economy. However, this only occurred during extreme events, which is a side-effect of the monetary policy on the foreign exchange market. These results contribute to the assessment of the space for manoeuvres by monetary policymakers regarding key policy rate modifications as a response to pandemic shocks.

KEYWORDS:

• Monetary policy
• COVID-19
• exchange rate
• unconditional quantile regression

JEL CLASSIFICATION:

• C21
• E44

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ The exchange rate is directly associated with trade balance, foreign debt, export competitiveness, and capital flows (Jora 2020).

² Croatia, Czech Republic, Denmark, Hungary, Norway, Poland, Romania, Serbia, Sweden, Switzerland, Turkey, and the United Kingdom. Our sample covers both the pre-Covid period (March 2019–February 2020) and the Covid period (March 2020–February 2021).

³ During the pre-Covid period, there were 10 episodes with changes in policy rates compared with 19 episodes during the Covid period.

⁴ Estimation values can be made available upon request.