Why Money Announcements Move Interest Rates: An Answer from the Foreign Exchange Market

29 Pages Posted: 27 Apr 2000 Last revised: 14 Nov 2022

See all articles by Charles M. Engel

Charles M. Engel

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Date Written: December 1982

Abstract

On a Friday that the Fed announces a money supply greater than had been anticipated, interest rates move up in response. Why? One explanation is that the market perceives the fluctuation in the moneystock as an unintended deviation from the Fed's target growth rate that will be reversed in subsequent periods. The anticipation of this future tightening drives up interest rates today. A second explanation is that the market perceives the increase in the money supply as signalling a higher target growth rate. The expected future inflation rate rises,which is reflected in a higher nominal Interest rate.This paper offers grounds for choosing between the two possible explanations: evidence from the exchange market. Under the first explanation, anticipated future tightening, one would expect the dollar to appreciate against foreign currencies. Under the second explanation,expected inflation, one would expect it to depreciate. We render these claims more concrete by a formal model, a generalization of the Dornbusch overshooting model. Then we use the mark/dollar rate toanswer the question. We find a statistically significant tendency for the dollar to appreciate following positive money supply surprises.This supports the first explanation.

Suggested Citation

Engel, Charles M. and Frankel, Jeffrey A., Why Money Announcements Move Interest Rates: An Answer from the Foreign Exchange Market (December 1982). NBER Working Paper No. w1049, Available at SSRN: https://ssrn.com/abstract=227180

Charles M. Engel (Contact Author)

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Jeffrey A. Frankel

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