Monetary autonomy, pegs, and floats in the Bundesbank era
In this paper, James Cloyne, Patrick Hürtgen, and Alan M. Taylor ask whether countries that float their exchange rate retain meaningful monetary independence and are thus insulated from foreign monetary shocks.
The authors construct a new series of exogenous German monetary policy shocks from 580 Bundesbank Central Bank Council meetings between 1974 and 1998. Their identification follows the Romer & Romer (2004) approach, but adapted to Germany, by digitizing previously unused archival briefing materials from the Bundesbank Historical Archive, which recorded the exact real-time data available to policymakers at each meeting (inflation, GDP growth, unemployment, money supply, bond yields, exchange rates). A “cleaning regression” orthogonalizes policy rate changes with respect to this information set, and the residuals become the shock series. They then use local projections on a panel of European countries, split into DM-pegs (Austria, Netherlands, Belgium, Denmark, France) and DM-floats (Sweden, Finland, Italy, Spain, Greece, UK), to estimate impulse responses for exchange rates, interest rates, industrial production, prices, and unemployment.
Three main findings
- Domestic effects are conventional: A Bundesbank tightening reduces inflation, output, and raises unemployment in Germany, consistent with standard monetary transmission.
- The trilemma holds clearly: After a 100 bps Bundesbank tightening, DM-pegs see no exchange rate movement but significantly higher domestic interest rates and sizable economic contractions (industrial production falls, unemployment rises). DM-floats, by contrast, see a large currency depreciation against the DM but no significant response in interest rates, activity, or prices as they are insulated.
- Placebo test with U.S. shocks confirms the mechanism: U.S. monetary tightenings have broadly similar effects on both DM-pegs and DM-floats ( as expected, since all European countries floated against the dollar) ruling out that the peg/float difference is driven by inherent country characteristics rather than the exchange rate regime itself.
Monetary and Financial Spillovers: New Historical Evidence from Germany
Authors: James Cloyne, Patrick Hürtgen, Alan M. Taylor
From: University of California, Davis, Columbia University, Deutsche Bundesbank
Exchange rate regimes and insulation in an integrated Europe
Do flexible exchange rates still insulate economies from external shocks in today’s highly open and financially integrated European economies, or has globalization rendered the classical insulation argument obsolete? This is the question Giancarlo Corsetti, Keith Kuester, Gernot J. Müller, Sebastian Schmidt, and Ben Schumann are attempting to answer in this paper.
The authors work with a panel of the euro area (EA) and 20 neighboring countries from January 1999 to April 2025 which includes a total of 6,300 country-month observations. Their identification of EA monetary policy shocks borrows from Jarociński & Karadi (2020), which combines high-frequency interest rate surprises with sign restrictions on stock prices to purge information effects. They also extract an EA main business cycle shock and an EA main exchange rate shock from a Bayesian SVAR to check whether findings generalize beyond monetary policy shocks. Theoretical interpretation relies on a two-country HANK model augmented with a financial channel (foreign-currency debt revaluation) and imperfect exchange rate pass-through.
Findings
- At high frequency, floats behave like floats: After an EA monetary tightening, floating currencies depreciate against the euro and their interest rates rise much less than in pegging countries, consistent with the trilemma.
- At business cycle frequency, there is no insulation: Industrial production and unemployment respond equally strongly in pegs and floats, more precisely, floats contract just as much as pegs. This holds not only for monetary policy shocks but also for the main EA business cycle shock and the main EA exchange rate shock.
- The HANK model rationalizes the puzzle: Household heterogeneity is the key ingredient. Under a float, currency depreciation is contractionary through two channels, namely, adverse real income effects (imports become more expensive) and foreign-currency debt revaluation, which both offset the expansionary expenditure-switching channel. These forces grow stronger as trade openness rises.
- Openness is the key moderating variable: The model predicts that as trade openness rises, a float provides less insulation relative to a peg. At the openness levels of their sample (avg. 82–114% of GDP), insulation disappears entirely.
The key distinction between the Corsetti et al. and the Cloyne et al. papers is trade openness: Cloyne et al.’s pre-euro European sample had average openness of 53–63% of GDP, low enough for the expenditure-switching channel to dominate and deliver clear insulation for floats. Corsetti et al.’s post-1999 sample has openness of 82–114% of GDP, where the contractionary channels dominate instead. So rather than contradicting each other, the two papers together tell a unified story: flexible exchange rates provided insulation in the less globalized Europe of the EMS era, but no longer do in today’s highly integrated European economy.
Exchange Rate Insulation Revisited
Authors: Giancarlo Corsetti, Keith Kuester, Gernot J. Müller, Sebastian Schmidt, Ben Schumann
From: European University Institute, University of Bonn, University of Tübingen, European Central Bank, University Berlin
