Effectiveness of conventional and unconventional monetary policy of the ECB on the exchange rate channel

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Effectiveness of conventional and unconventional monetary policy of

the ECB on the exchange rate channel

Key words: Monetary policy, Conventional, Unconventional, Exchange rate Abstract:

I analyze the effect of conventional and unconventional monetary policy announcement on the value of the euro. I compare which type of announcement has a stronger impact on the euro, compared to three major currencies: US dollar, British Pound and Japanese Yen. As the topic of the announcement can also have an impact, I distinguish for the conventional monetary policy between the announcements about policy rates and open market operations. For unconventional monetary policy, I investigate the following topics: negative deposit rate, outright monetary transactions, asset purchase programme and the enhanced credit support. In order to test the impact, I use dummy variables for the announcement and topics. I found an overall significant effect of the different topics on the exchange rates, however announcements about outright monetary transactions had no significant effect. Additionally, whether there was a significant effect of the announcement topic on the value of the euro depended on the corresponding exchange rate.

Name: Sander Carras Student number: S2757567

Supervisor: prof. dr. J. (Jakob) de Haan

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1. Introduction

1.1 Research Area

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export, which has a positive effect on economic growth (Dani, 2008; Vohra, 2001) Thus, inadequate economic growth and tendency towards deflation, which the eurozone experienced during the global financial crisis, can be countered with measures that have a depreciating effect on the euro (Grauwe, 2018; Mishkin, 2001).

1.2 Background & Context

The then-president of the ECB, Mario Draghi, held on the 26e of July 2012 his famous ‘whatever it takes’ speech, where he mentioned that he would do whatever it takes to save the Euro (Alcaraz, Claessens, Cuadra, Marques-Ibanez & Sapriza, 2018). Central banks have been forced to rely on unconventional monetary policy methods, due to the ineffectiveness of conventional policies at the effective lower bound (Inoue & Rossi, 2019). Additionally, when economic shocks are so large, the conventional tools are not enough. Examples of the unconventional monetary policies include altering the size and composition of Central Banks’ balance sheet the announcements about the future monetary policy paths and lowering the deposit rate below the zero interest rate. But how effective are these unconventional monetary policies tools in the transmission towards the international financial markets, compared to the conventional tools that were used before.

Between October 2014 and December 2018, the ECB conducted several net purchases of securities under one of the Asset Purchase Programs (APP). Between January 2019 and October 2019, the Euro system fully reinvested the principle payments from the maturing securities held in the APP portfolios. In September 2019 it was announced that the ECB Governing Council had decided to restart the APP program from the first of November.

As the ECB had recently restarted the APP program, I would be interested in the effectiveness of the previous unconventional monetary policy on the value of the Euro. By comparing the conventional monetary policy with the unconventional monetary policy (De Fiore & Tristani, 2019), I would be able to identify how the monetary policy announcement have affected the euro exchange rate and compare the conventional and unconventional monetary policy measures with each other.

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announcements. The announcement made after 2014, are all considered unconventional monetary policy announcement as the deposit rate passed the zero threshold.

Therefore, the research questions will be the following:

“What is the effect of conventional monetary policy announcements compared to unconventional monetary policy announcements of the ECB on the euro exchange rate between 2002 and 2020?

Is there a differential effect for conventional and unconventional policies?”

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2. Literature

Until 2008, the ECB had only used conventional monetary policy. However, the fall of Lehman in 2008, distorted the financial market. The ECB had to implement different measures, as the conventional methods were not enough. Between 2008 and 2014, the ECB used both standard and non-standard monetary policy measures. Next, I will discuss how the ECBs measures impact the real economy through different transmission channels. Furthermore, I will describe the conventional and unconventional monetary policy period. Lastly, I discuss previous literature of monetary policy announcement on the exchange rate.

2.1 Transmission channels

The ECB uses several instrument to affect inflation and output through several channels. Changes in the money market rates by the ECB have an impact on the interest rate that is set by banks for short-term loans and deposits (Interest channel). Additionally, the changes in the central banks can influence the supply of credit (credit channel). This occurs through the bank lending channel, the balance sheet channel and the risk taking channel. An increase in interest rate, may reduce the amount of borrowers that can repay the loans and therefore there might be a decrease in the amount of loans issued (bank lending channel). Furthermore, the changes in interest rates also affect firms’ balance sheets. The increase in interest rates, decreases the net worth of assets, leading to lower collateral value, which means a reduced ability to borrow. The risk taking channel happens through two mechanisms. Firstly, low interest rate boost the value of assets and collateral. An seemingly sustainable increase in the value of assets, leads to higher risk taking for both borrowers and banks. Secondly, lower interest rates pushes agents to riskier assets that offers high yields. The changes in the interest rates can also influence the exchange rate, that may again affect inflation (exchange rate channel). First, the exchange rate movement may directly affect the domestic price of imported goods. If the exchange rate depreciates, the price of the imported goods tends to increase, which might directly increase inflation. Secondly, lower prices of imported production goods, may lead to lower prices of the final goods. Thirdly, a depreciation of currency, makes the local produced goods more competitive and increases the overall demand pressure. An depreciation of the exchange rate increases the inflationary pressure. Lastly, the central bank can influence the expectation channel. It influences the long term expectations, by guiding economic agents’ future expectations of inflation. The future expectations affect the wage- and price setting behavior. (ECB, 2011; Beyer et all., 2017; De Haan, Schoenmaker & Wierts, 2020).

2.2 Conventional monetary policy

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The standing facilities can be divided into the deposit facility and the marginal lending facility. Bank’s use those facilities if they need liquidity or if they want to stall liquidity. The deposit facility is used to absorb excess liquidity from banks at below-market rates, while the marginal lending facility provides liquidity to banks against collateral at above-market rates (Lenza, & Reichlin, 2010). The interest rates on these standing facilities are considerably higher for borrowing and lower for depositing, than the money market rates. Bank’s use these facilities in the absence or alternatives. As there are barely any limits on these facilities (except for collateral), the marginal lending facility provides a ceiling and the deposit facility provides a floor for the overnight rate in the interbank market (De Haan, Schoenmaker & Wierts, 2020). By setting the rates on the standing facilities, the ECB can determine the corridor in which the overnight money market can fluctuate. Another conventional monetary tool the ECB uses are the open market operations. It allocates an amount of liquidity that allows banks to fulfil their liquidity needs at a price that is suitable with the intentions of the ECB. It is done by buying and selling financial assets to banks. For example, if assets are bought from a bank, the reserves of that bank held by the central bank increases. Three types of open market operations are used: Main refinancing operations, (MROs) longer-term refinancing operation (LTROs), and fine tune operations (FTOs). These open market operations are in a firm of a reserve transaction, in which the central banks buys assets from the bank under a repurchase agreement or grants a loans against assets as collateral. This minimizes the risk exposure on the central bank’s balance sheet (Lenza, & Reichlin, 2010). MROs are liquidity-providing repo operations conducted as variable rate tenders, subject to a minimum bid rate, in which the ECB determines the total amount that is allotted to counterparties, while banks submit bid schedules stating the price they are willing to pay for liquidity in these operations (Hartmann and Smets, 2018). In addition to the MROs, there are monthly LTROs. These are designed to provide longer-term liquidity in the banking system. Lastly, the ECB might use FTOs when necessarily. The FTOs mainly operate to steer interest rates, to smooth the effects of unexpected liquidity fluctuations in the market on interest rates. These actions have ensured a reliable method to provide stimulus in economic downturns and of containing the inflationary pressure in economic upturns (ECB, 2011).

2.3 Unconventional monetary policy

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De Haan, Schoenmaker & Wierts (2020), divides the ECB’s unconventional monetary policy into three main phases. First, the global financial crisis, that started in September 2008 with the collapse of Lehman. Second, the Euro crisis starting in May 2010 and lastly, the declining inflation and sluggish economic recovery after 2013. At the start of the financial crisis in 2008, the ECB reduced the key interest rates to historically low levels. Additionally, it began with temporary non-standard measures, such as the Enhanced Credit Support. During the second phase, the ECB had to intervene in the sovereign debt markets. In the third phase, there was a tendency towards deflation, while interest rates could not be reduced any further.

Before the financial crisis, the ECB provided a fixed amount of liquidity to banks against collateral. Additionally, banks could lend and borrow on the interbank market to fulfil their liquidity needs. However, the fall of Lehman Brothers in September 2008, froze the financial market. Besides the reduction in the policy rates, the ECB reacted with multiple measures to satisfy the high demand for liquidity. These measures became know as enhanced credit support (ECS). The ECB began providing unlimited credit to banks at a fixed interest rate referred as fixed-rate full allotment. Furthermore, the list of collateral was extended, allowing banks use more of their assets to obtain the additional central bank liquidity. In 2009, more unconventional monetary policy measure where implemented, such as the announcements of the lengthening of the maturity of LTROs and the first outright purchase program by the ECB, the covered bond purchase program (CBPP). This program was followed by a second CBPP in 2011 and a third CBPP in 2014.

In the second phase, the ECB introduced the Securities Markets Programme (SMP) in response to the rising wedge in yields of the 10-year bonds of some euro-area governments. The unsustainable interest rates was considered to impair the transmission of policy interest rate decisions to the real economy (Cour-Thiman & Winkler, 2014). Even after all these actions, there were still signs that bank’s were not able to provide credit. Overall, there was doubt whether the European monetary union (EMU) was sustainable. Therefore, on the 26 July 2012, the former president of the ECB Mario Drahgi made the famous statement “whatever it takes to preserve the euro”, followed by the intentions to perform outright monetary transaction (OMTs) in the secondary bond markets on 2 August. This addressed the distortion in the bond markets, that came from the fear that the euro would collapse.

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which created long-term attractive funding to further ease the private sector and stimulated the lending of banks to the real economy. In January 2015, the ECB expanded the asset purchase programme (APP), which is often called quantitative easing (QE). At the end of 2015 and beginning of 2016, the ECB lowered the interest rates further and announced a considerable expansion to the APP. The program was extended to the end of 2018 and it used forwards guidance by stating that the policy rates remain at the current level until at least the summer of 2019. Lastly, in September 2019 is was announced that the ECB would restart APP again in November 2019. 2.4 Monetary policy and the exchange rate

As been widely studied, monetary policy changes have an influence on the exchange rate (Inoue & Rossi, 2019; Glick & Leduc, 2015, Demir, 2014; Cecioni, 2018). Zettelmeyer (2000), studied the effect of monetary policy on the exchange rate of Australia, Canada and New Zealand. He found a significant response of the exchange rate to policy shocks in the direction that was traditionally assumed. Thus, a contraction leads to an appreciation and vice versa.

During the conventional times it was found that generally a monetary policy tightening would lead to an appreciation of that country’s nominal spot exchange rate and that an expansionary shock typically leads to a depreciation of the currency (Clarida & Gali, 1994; Eichenbaum & Evans, 1996). Additionally, Inoue & Rossi (2019) find that the effect on exchange rates differ depending on how monetary policy affects agents, especially on the expectations and perceived risks/uncertainty in the economy. In particular, the appreciation that follows a contractionary monetary policy shock is mostly due to changes in expectations in the short run. Thus, the monetary policy announcement had in general a short term impact.

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10 conventional and unconventional monetary policy on the European stock market. They found that both types of monetary policy had an effect on the stock market, however unconventional monetary policy was found to have stronger effect compared to the conventional monetary policy.

The monetary policy announcement itself, is considered an important transmission channel. Gurkaynak, Sack & Swanson (2004) stated, the Federal Reserve announcement following its January 28 2004, policy meeting led to one of the largest reactions in the Treasury market on record. The reaction wasn’t from what the FOMC did, but rather by what it had said: the decision to leave the current federal funds rate unchanged was completely anticipated by financial markets, but the FOMC’s decision to drop the phrase “policy accommodation can be maintained for a considerable period” from its accompanying statement and replace it with “the Committee believes it can be patient in removing its policy accommodation” was read by financial markets as indicating that the FOMC would begin tightening policy sooner than previously expected. Additionally, Gurkaynak, Sack & Swanson (2004). found that 75 to 90 percent of the explainable variation in five and ten-year Treasury yields in response to monetary policy announcements is due to path factors (associated with statements) rather than to change in the federal funds rate target. A study of Ederington & Lee (1993) analyzed the effect of scheduled macroeconomic news announcement on the volatility of the dollar-German mark exchange rate. They concluded that the announcements about merchandise trade, employment, producer price index and retail sale, influenced the volatility of the exchange rate. DeGenarro & Shrieves (1997), examine the impact of three news categories : macroeconomic, economic policy and interest rate news. They found that these news categories all are important determinants of the exchange rate volatility. Tivegna (2002), looks at scheduled and non-scheduled news on the exchange rates and finds that the statements made by policy makers have a strong impact on the exchange rate. Galati & Ho (2003) analyze the relationship between the scheduled macroeconomic news and the change in the euro-dollar exchange rate on a daily basis, with a focus on the US and European news announcements. They found that the unexpected part of macroeconomic news announcements can explain up to 10% of the variation of the euro-dollar exchange rate. Fatum & Hutchison (2002), analyze the impact of the ECB intervention or intervention related news on the euro-dollar exchange rate. They divided the news into four separate categories of news: rumors of intervention, statements by officials supportive of the euro, statements by officials unsupportive of the euro and report of intervention. They conclude that rumors of intervention have an positive effect on the exchange rate and unsupportive statements have a negative effect on the euro-dollar exchange rate.

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3. Methodology

3.1 Model

As announcements of monetary policy in the US had a major impact on the value of assets, I believe it is important to see how the announcements of the ECB during the conventional and unconventional monetary policy have influenced the value of the Euro. By examining the announcement between 2002 and 2020, I would be able to compare how effective the different monetary policy announcements have been. This might give some addition information on how monetary policy effected the exchange rate and give some potential insights for future policy implementation. As been concluded, monetary easing in general had a depreciating effect on the Euro exchange rate and monetary tightening has the opposite effect (Zettelmeyer, 2000). In order to measure if the announcements of the ECB had an impact on the Euro I will examine the value of the Euro compared to the US dollar (USD), Japanese Yen (JPY) and British Pound (GBP). The comparison with these three different major currencies should give a more complete overview on how the value of the euro reacts to the monetary policy announcements.

The monetary policy surprises can only occur on monetary policy events days. The method presumes efficient markets hypothesis, where the current value of the euro exchange rate reflect all the available information in the market (Malkiel, 1989). Therefore, press releases by the ECB might provide the market with new information and this has an effect on the value of the euro. By analyzing the value of the exchange rate on non-monetary policy days compared to monetary policy days, I would be able to tell how these monetary policy announcement have an effect on the value of the Euro in comparison to the other currencies. Since there are two categories, announcement days and no announcement days, I will use a dummy variable. Furthermore, dummy variables are used to indicate the content of the specific announcement. For conventional monetary announcements there is a dummy variable for policy rates and for open market operations (OMO). For the unconventional announcements, there is a dummy variable for the negative policy rates, outright monetary transactions (OMT), asset purchase programme (APP) and enhanced credit support (ECS) The dummy variable will indicate if the observation belongs to one of the two options.

I will use is a multiple linear regression for both regressions. The model for conventional monetary policy is:

𝑋𝑡 = 𝛽0+ 𝛽1𝐶𝑀𝑃𝑡+ 𝛽2𝑃𝑟𝑡+ 𝛽3𝑂𝑚𝑡+𝜀𝑡

The regression for the unconventional monetary policy is:

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Here 𝑋_𝑡 represents the value of the euro in comparison to one of the other major currencies at time t, 𝐶𝑀𝑃_𝑡 is the dummy variable that indicates whether there is a conventional monetary policy or not at time t, and 𝑃𝑟𝑡 is a dummy for if there was a announcement about the policy rates of the

ECB at time t, 𝑂𝑚𝑡 is a dummy for if the announcement was about open market operations or not

at time t and lastly, 𝜀_𝑡 is the error of the estimation.

For unconventional monetary policy 𝑋_𝑡 represents the value of the euro in comparison to one of the other major currencies at time t, 𝑈𝑀𝑃𝑡 is the dummy variable that indicates whether there is a

unconventional monetary policy announcement or not at time t, 𝑁𝑃𝑟_𝑡 is a dummy variable about if the announcement was about a negative policy rate at time t, 𝑂𝑀𝑇_𝑡 is a dummy variable for if the announcement was about the outright monetary transaction or not at time t, 𝐴𝑃𝑃_𝑡 is a dummy for whether there was an announcement about the Asset Purchase Programme at time t, 𝐸𝐶𝑆𝑡

represents a dummy for if there was an announcement about Enhanced Credit Support at time t and lastly, 𝜀_𝑡 is the error term.

I will run three separate regression with a different dependent variables, the value of the euro compared to the US dollar (USD), Japanese Yen (JPY) and British Pound (GBP).

3.2 Data

In order to examine the effect of a monetary policy announcement on the value of the euro, I will use the euro exchange rate compared to three other major currencies and the days of the monetary announcements. The announcement made by the ECB have always a specific topic. The topic is withdrawn from the statement made on the ECB website. In the following sections I will describe the data in more detail.

3.2.1 Exchange rate

The euro exchange rate I will be referring to is the euro exchange rate compared to three major currencies. These include the US dollar (USD), the Japanese Yen (JPY) and the pound Sterling (GBP). By comparing the Euro exchange rate to these others currencies, it will decrease the overall influence of the monetary policy statements of the United States, Japan and Great Britain. I will be using the daily euro exchange rate in comparison of the other major currencies over the period from 1 January 2002 till 31 December 2019 from the Eikon database.

Variable Observations Mean Standard

deviation

Minimum Maximum

Euro/ USD 4965 1.242627 .1398509 .8586 1.5999

Euro/ GBP 4,694 .783953 .0894246 .6084 .9762

Euro/ JPY 4965 130.2354 15.15266 94.26 169.47

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During this time, the value of the euro compared to the other currencies have deviated substantially. The EUR/USD exchange rate had an average value of 1.2426, with a standard deviation of 0,1399. At the beginning of 2002, the value of the Euro was the lowest. For one euro you were able to get 0.8568 dollar. In the middle of the year 2008, the value of the euro was the highest. At the highest point, with one euro you would be able to get almost 1.60 USD.

The value of the Euro in comparison with the British pound was on average worth 0.78395 with a standard deviation of 0.08942. The value of the euro compared to the British pound was the lowest at the beginning of 2002, with a value of 0.6084. On the contrary, in January 2009 the value had reached a maximum of 0.9762.

Lastly, the value of the EUR/JPY exchange rate was on average 130.2354 with a standard deviation of 15.15266. The value of the euro in comparison with the Japanese Jen was the lowest in august 2012, it was worth 94,26. On the contrary, the Euro was valued the highest, in comparison with the Jen, in august 2008 with a value of 169,47.

The value of Euro in comparison with the other three major currencies can be found in the graphs below. First the EUR/USD exchange rate, following by the EUR/GBP and EUR/JPY.

0.7000 0.8000 0.9000 1.0000 1.1000 1.2000 1.3000 1.4000 1.5000 1.6000 1.7000

EUR/USD exchange rate

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14 0.5500 0.6000 0.6500 0.7000 0.7500 0.8000 0.8500 0.9000 0.9500 1.0000

EUR/GBP exchange rate

90.00 100.00 110.00 120.00 130.00 140.00 150.00 160.00 170.00 180.00

EUR/JPY exchange rate

Graph 2– Euro/British Pound exchange rate from 2002 until 2020

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3.2.2 Monetary Policy Announcements

In order to identify the effect of the monetary policy announcement on the value of the euro exchange rate, I need the days that the ECB released statements about monetary policy. When the ECB makes any policy adjustments, there is an official press release where this information is communicated to the rest of the world. These press releases about monetary policy are retrieved from the site of the ECB. During the period from January 2002 to 31 December 2019 there have been a total of 354 announcements days with a total of 4695 days. Some of the announcements made, cover several different monetary policy topics. However, since these announcements happen on the same day, I would still be able to identify the difference between the monetary policy announcements days, in comparison with non-monetary policy announcements days. There were a total of 354 announcement days dispersed over 18 years, therefore on average there are a total of 20 announcement days in a year. The year 2008 has been the year with the most policy days, with a total of 33 announcement days in comparison with 2018 with only 9 announcement days. In table 3, you can find all the announcement days about monetary policy that were released by the European Central Bank. All the announcements, with a detailed description, can be found on the official cite of the ECB.1

3.2.3 Content of the announcements

The content of the announcement might also matter for the reaction of the exchange rate. As been previously stated, the detailed press releases can be found on the website of the ECB1. By analyzing these statements, I was able to divide these conventional and unconventional monetary policy statements into different topics. There were monetary policy days, where the ECB released statements about more than one of the topics. The conventional monetary policy is divided into two different topics. The first being the policy rate and the second begin the open market operations. The unconventional monetary policy announcement are divided into four topics. Namely, the negative interest rate, outright money transactions, asset purchase program and the enhanced credit support. The amount of statements about these topics can be found in table 2.

1_{See ECB website of all press releases about monetary policy}

(https://www.ecb.europa.eu/press/pr/activities/mopo/html/index.en.html)

Content announcement Number of observations

Conventional monetary policy 216

Policy rates 134 Open market operations 169

Unconventional monetary policy

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YEAR MONETARY POLICY DAY

2002 03/01, 07/02, 14/02, 07/03, 04/04, 23/04, 26/04, 02/05, 06/06, 01/07, 04/07, 05/07, 10/07, 22/07, 01/08, 02/08, 12/09, 10/10, 07/11, 05/12, 2003 09/01, 23/01, 06/02, 28/02, 06/03, 03/04, 05/05, 08/05, 05/06, 02/07, 10/07, 31/07, 01/08, 04/09, 30/09, 02/10, 28/10, 06/11, 18/11, 04/12 2004 08/01, 12/01, 15/01, 16/01, 30/01, 05/02, 06/02, 16/02, 25/02, 27/02, 04/03, 05/03, 01/04, 26/04, 06/05, 10/05, 03/06, 01/07, 05/08, 13/08, 02/09, 07/10, 04/11, 02/12 2005 13/01, 14/01, 03/02, 21/02, 02/03, 03/03, 07/04, 21/04, 04/05, 30/05, 02/06, 06/06, 07/07, 04/08, 01/09, 06/10, 03/11, 01/12, 27/12 2006 12/01, 13/01, 20/01, 02/02, 02/03, 06/04, 04/05, 08/06, 06/07, 03/08, 31/08, 15/09, 05/10, 02/11, 07/12 2007 03/01, 11/01, 08/02, 13/02, 08/03, 16/03, 12/04, 10/05, 25/05, 06/06, 11/06, 18/06, 26/06, 05/07, 10/07, 02/08, 14/08, 22/08, 06/09, 04/10, 30/10, 08/11, 30/11, 06/12, 12/12 2008 10/01, 07/02, 06/03, 11/03, 28/03, 10/04, 02/05, 08/05, 28/05, 29/05, 05/06, 03/07, 30/07, 31/07, 07/08, 04/09, 29/09, 02/10, 03/10, 07/10, 08/10, 13/10, 15/10, 17/10, 23/10, 27/10, 03/11, 06/11, 12/11, 17/11, 26/11, 04/12, 19/12 2009 15/01, 16/01, 05/02, 05/03, 19/03, 02/04, 06/04, 07/05, 29/05, 04/06, 10/06, 25/06, 02/07, 06/08, 03/09, 24/09, 08/10, 05/11, 20/11, 03/12 2010 14/01, 18/01, 27/01, 04/02, 05/02, 04/03, 08/04, 23/04, 02/05, 03/05, 06/05, 10/05, 10/06, 30/06, 08/07, 28/07, 05/08, 02/09, 07/10, 09/10, 14/10, 27/10, 04/11, 02/12, 16/12, 17/12, 21/12, 2011 13/01, 03/02, 04/02, 03/03, 07/04, 05/05, 06/05, 03/06, 09/06, 29/06, 07/07, 04/08, 25/08, 08/09, 21/09, 30/09, 04/10, 06/10, 03/11, 30/11, 08/12, 16/12 2012 12/01, 09/02, 28/02, 08/03, 04/04, 05/04, 03/05, 06/06, 22/06, 05/07, 20/07, 02/08, 06/09, 12/09, 28/09, 04/10, 08/10, 31/10, 08/11, 27/11, 28/11, 06/12, 13/12, 19/12, 2013 10/01, 07/02, 21/02, 07/03, 22/03, 04/04, 02/05, 06/06, 28/06, 04/07, 05/07, 18/07, 01/08, 05/09, 16/09, 27/09, 02/10, 10/10, 31/10, 06/11, 07/11, 22/11, 05/12, 2014 09/01, 24/01, 06/02, 06/03, 03/04, 08/05, 05/06, 17/06, 03/07, 17/07, 29/07, 07/08, 04/09, 18/09, 02/10, 17/10, 30/10, 06/11, 07/11, 04/12, 18/12, 2015 14/01, 22/01, 04/02, 20/02, 05/03, 15/04, 03/06, 18/06, 22/06, 16/07, 31/08, 03/09, 23/09, 22/10, 09/11, 20/11, 26/11, 03/12, 2016 21/01, 05/02, 10/03, 21/04, 03/05, 02/06, 22/06, 21/07, 08/09, 14/09, 27/09, 05/10, 20/10, 03/11, 08/12, 15/12, 2017 19/01, 09/03, 27/04, 08/06, 13/06, 19/06, 20/07, 07/09, 26/10, 14/12 2018 25/01, 08/03, 26/04, 14/06, 11/07, 26/07, 13/09, 25/10, 13/12 2019 24/01, 30/01, 05/03, 07/03, 22/03, 10/04, 13/05, 06/06, 25/07, 29/07, 09/08, 12/09, 24/10, 12/12

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4. Results

First, I will discuss the effect of the conventional monetary announcement on the value of the euro, considering the different topics. Secondly, the effect of the unconventional monetary policy announcement will be given and how the different monetary policy topics have influenced the value of the euro exchange rate.

4.1 Conventional monetary policy

Table 4 shows the results from the conventional monetary policy announcement. The conventional monetary policy announcement had a weakly significant effect on the value of the EUR/USD exchange rate and a moderate significant effect on the EUR/GBP exchange rate, but not significant effect EUR/JPY exchange rate. A conventional monetary policy announcement decreased the value of the euro in comparison with the dollar by 0,0385 and the value of the euro in comparison with the British pound by 0,0316.

The monetary policy announcement that included the topic about policy rates had a weakly significant effect on the value of the EUR/USD exchange rate and were strongly significant for the EUR/GBP and EUR/ JPY exchange rate. EUR/USD and EUR/JPY exchange rate depreciated by 0,0496 and 15,99 respectively. However, the value of the EUR/GBP appreciated with 0,0436 due to a monetary policy announcement including the policy rates.

Lastly, announcements of the ECB that included statement of open market operations had a significant effect on the value of the EUR/USD and EUR/JPY exchange rate. Overall, these announcement appreciated the euro compared to the dollar with 0,0799 and the euro compared to the Japanese Jen with 15,58.

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4.2 Unconventional monetary policy

Table 5 shows the results of the unconventional monetary policy on the value of the euro. Overall, the unconventional monetary policy announcement self are weakly significant for the EUR/GBP and moderately significant for the EUR/JPY. However, they do not show a significant effect on the value of the EUR/USD exchange rate. The euro compared to the British Pound depreciated by 0,0166, while the EUR/JPY appreciated by 4,323 due to the unconventional monetary policy announcements.

In addition, unconventional monetary announcement that cover the negative deposit rate have a weakly significant effect on the EUR/USD exchange rate and a moderate effect on the EUR/GBP exchange rate. The euro compared to the dollar depreciated with 0,058 and the euro compared to the British pound depreciated with 0,03 due to the announcement about the negative deposit rates. The unconventional announcement about the outright money transactions had no significant effect on the value of the euro compared to any of the exchange rates.

Furthermore, the announcement about the asset purchase program had only a strong significant Table 4 – Regression output of the dummy variable conventional monetary policy

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effect on the EUR/GBP exchange rate. The euro compared to the British pound appreciated by 0,0512 on average.

Lastly, the announcement about the enhanced credit support had a strong significant effect on the value of the EUR/USD and the EUR/JPY exchange rate. The euro compared to the dollar appreciated due to these announcement by 0,0895, while the euro compared to the Japanese Yen depreciated by 7,39.

Overall, the unconventional monetary policy announcements were partly significant on the exchange rate. However, announcement about OMT were not significant at all and announcement about the asset purchase programme were only significant to the EUR/GBP exchange rate.

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5. Conclusion

To conclude, I have analyzed the effect of the conventional monetary policy and unconventional monetary policy on the euro exchange rate compared to the US dollar, British Pound and Japanese yen. First, I have described how the central bank’s policy might transmit to the economy by describing the serval transmission channels. Furthermore, an summary was given of the conventional monetary policy tools, that included the ECBs policy rates and the open market operations. Followed by the unconventional monetary policy measures that the ECB began implementing from 2008, when the conventional monetary tools were not enough anymore. The literature of the conventional and unconventional monetary policy announcements on the exchange rate stated that the announcements had a significant effect on exchange rate. Some authors found a stronger effect of the unconventional monetary policy announcement compared to the conventional announcements.

For the conventional monetary policy, I ran a multiple linear regression on the EUR/USD, EUR/GBP and EUR/JPY with the dummy variables: conventional monetary policy, policy rates and open market operation. I found that an announcement of conventional monetary policy had a weak and moderate significant effect on the EUR/GBP and EUR/JPY. Additionally, announcement about the policy rate had a significant effect on all three exchange rates and announcement about the open market operation had only a significant effect on the EUR/USD and EUR/JPY.

Considering the unconventional monetary policy, I ran the multiple linear regression on the EUR/USD, EUR/GBP and EUR/JPY with the dummy variables: unconventional monetary policy, negative deposit rate, outright monetary transaction, asset purchase programme and the enhanced credit support. I found that the unconventional monetary policy days had only a significant effect on the EUR/GBP and EUR/JPY exchange rate. Furthermore, the announcement about the negative deposit rate had a weak to moderate significant effect on the EUR/USD and the EUR/GBP respectively. Additionally, no significant effect of announcements about outright monetary transactions on the exchanges rates were found. The announcement about the asset purchase programme had only a significant effect on the EUR/GBP. Lastly, the announcement about the enhanced credit supply were found to have a significant effect on the EUR/USD and EUR/GBP exchange rates.

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Effectiveness of conventional and unconventional monetary policy of the ECB on the exchange rate channel