Monetary Policy Asymmetries and Inflation Gaps: When the Fed Moves and the ECB Waits

Abstract

This paper investigates how inflation differentials and asynchronous monetary policy responses between the United States and the Euro Area have shaped USD/EUR exchange rate dynamics in the post-pandemic period. While inflation surged on both sides of the Atlantic between 2021 and 2023, the Federal Reserve reacted swiftly and decisively with an aggressive cycle of interest rate hikes. In contrast, the European Central Bank delayed its response, maintaining accommodative conditions for longer despite rising price pressures. This divergence created significant monetary policy asymmetries with clear effects on financial markets and international capital flows. The faster pace of tightening in the United States increased the attractiveness of dollar-denominated assets and strengthened the dollar, while the euro depreciated as European rates remained lower for an extended period. Using comparative data from 2020 to 2025, including consumer price indices, policy rate decisions, and exchange rate fluctuations, this study explores the transmission mechanisms linking monetary policy divergence, inflation expectations, and currency valuation. The findings suggest that inflation gaps, when combined with differences in central bank timing and intensity, have a direct and lasting impact on the USD/EUR exchange rate. The analysis highlights how credibility and expectation management are essential for monetary authorities in sustaining exchange rate stability within an interconnected global financial system. JEL: E52, E31, F31, G12