We present a new data fact: in response to a monetary tightening, the domestic currency tends to appreciate in developed countries but depreciate in developing countries. A model is developed to rationalize this contrasting pattern. It has three key channels of monetary transmission: a liquidity demand channel, a fiscal channel, and an output channel. The paper shows that a calibrated version of the model can explain the contrast between developed and developing countries. Using counterfactual experiments and empirical evidence, we identify differences in the liquidity demand effect as critical in explaining the contrasting responses generated by the model. (JEL E23, E43, E52, F31, F33, O19)
Hnatkovska, Viktoria, Amartya Lahiri, and Carlos A. Vegh.
"The Exchange Rate Response to Monetary Policy Innovations."
American Economic Journal: Macroeconomics,
Interest Rates: Determination, Term Structure, and Effects
International Monetary Arrangements and Institutions
International Linkages to Development; Role of International Organizations