Monetary Policy and Exchange Rate Shocks in Brazil: Sign Restrictions versus A New Hybrid Identification Approach

Abstract

This paper analyzes the impacts of monetary policy, exchange rate, demand, and supply exogenous disturbances on the Brazilian economy using a structural vector autoregression model identified by two alternative methodologies. The first uses sign restrictions on impulse responses based on an open-economy macroeconomic model.  The second (hybrid) is a new methodology that combines the first with restrictions on the contemporaneous causal interrelationships among variables, derived by Directed Acyclic Graphs.

 A comparison of the results shows that while the effects of exchange rate shocks are nearly the same, the effects of monetary policy shocks depend on the methodology adopted. There is a strong response of the exchange rate to demand shocks and to shocks originating in the foreign exchange market. Exchange rate shocks have an important role in explaining short-run fluctuations of prices and output. We conclude that the exchange rate is an independent source of shocks and a shock absorber.