The Response of G7 Real Exchange Rates to Oil Price Shocks

This paper evaluates the response of G7 real exchange rates to oil supply and demand shocks developed by Kilian (2009). We find evidence suggesting that oil shocks are associated with the appreciation (depreciation) of real exchange rates for oil exporting (importing) countries. Further evidence, based on the analysis of forecast error variance decomposition, indicates that oil-specific demand shocks are the main contributor to variation in real exchange rates, whereas oil supply shocks contribute the least. Finally, regarding the role of monetary policy in responding to oil and exchange rate shocks, we find evidence showing monetary policy reacts only to oil-specific demand and aggregate demand shocks in three countries, whereas monetary policy responds to real exchange rate fluctuations in four countries.