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Why do market interest rates respond to money announcements?

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  • Daniel L. Thornton

Abstract

A number of studies have attempted to determine why money market interest rates are positively correlated with unanticipated increases in the money stock by examining the response of the foreign exchange and stock markets to money announcements. They report a significant positive relationship between the trade-weighted exchange rate and unanticipated increases in the money stock and a significant negative relationship between unanticipated increases in the money stock and stock prices. These results are taken as evidence in favor of the "unanticipated-liquidity-effect" explanation of the money market's response. This paper analyzes the response of these markets and investigates the consistency of the response to unanticipated changes in the money stock across markets. We find that the results for the foreign exchange and stock markets are sensitive to a few "outliers" so that these markets do not respond strongly to unanticipated changes in the money stock. Furthermore, all three markets generally do not respond significantly to the same money announcements. We conclude that the often-cited evidence is not sufficient to differentiate the anticipated–liquidity–effect from competing explanations of the money market's response to unanticipated changes in the money stock.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1988-002.

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Date of creation: 1988
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Publication status: Published in Journal of International Financial Markets, Institutions and Money, 1991, 1(1), pp. 33-60
Handle: RePEc:fip:fedlwp:1988-002

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Related research

Keywords: Interest rates ; Money market ; Money supply;

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  1. Hakkio, Craig S & Pearce, Douglas K, 1985. "The Reaction of Exchange Rates to Economic News," Economic Inquiry, Western Economic Association International, vol. 23(4), pages 621-36, October.
  2. Hardouvelis, Gikas A., 1987. "Macroeconomic information and stock prices," Journal of Economics and Business, Elsevier, vol. 39(2), pages 131-140, May.
  3. R.W. Hafer, 1986. "The response of stock prices to changes in weekly money and the discount rate," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 5-14.
  4. Daniel L. Thornton, 1988. "The borrowed-reserves operating procedures: theory and evidence," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 30-54.
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