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Title: The impact of carry trade activity on the transmission of monetary policy Authors:  Thomas Zoerner - Oesterreichische Nationalbank (Austria) [presenting]
Maximilian Boeck - Vienna School of International Studies (Austria)
Alina Steshkova - Vienna University of Economics and Business (Austria)
Abstract: Currency markets are shaped by a variety of puzzles and influenced, inter alia, by the current monetary policy stance. This gives rise to carry trade strategies that seek to exploit existing global interest rate differentials. We study how carry trade activity affects the transmission of monetary policy on currency markets. After monetary and non-monetary news from the central bank, investors may quickly unwind their positions in currencies featuring high-carry trade activity. To infer these effects from data, a threshold vector autoregressive model is fitted to discriminate between different regimes of carrying trade activity and estimate the effects of monetary policy shocks for a large set of currencies vis-a-vis the US dollar. Empirical evidence shows that carry trade activity indeed affects the transmission of monetary policy to exchange rate markets, causing different adjustment dynamics. Thus, we conjecture that the exchange rate channel and its behavioral component is an important dimension of monetary policy and need to be taken properly into account.