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Do Exchange Rates Respond to Day-to-Day Changes in Monetary Policy Expectations? Evidence from the Federal Funds Futures Market

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Author Info

  • Rasmus Fatum

    (University of Alberta)

  • Barry Scholnick

    (University of Alberta)

Abstract

This paper is the first to utilize the informational content embodied in Federal funds futures contracts for extracting day-to-day changes in expectations of future US monetary policy, in the context of a study of day-to-day exchange rate changes. We analyze more than 12 years of daily exchange rate data and show that continuous day-to-day changes in expectations of future US monetary policy has a significant and systematic impact on day-to-day changes in exchange rates. Our results imply that monetary policy matters for daily exchange rate determination in more ways than merely through infrequent, actual policy changes. Furthermore, when focusing on the actual monetary policy changes, the paper confirms that only the unexpected element of a policy change impacts exchange rates. The presented findings are generally consistent with the notion that exchange rates are forward-looking asset prices.

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Bibliographic Info

Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 03-18.

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Length: 32 pages
Date of creation: May 2003
Date of revision: Aug 2003
Handle: RePEc:kud:epruwp:03-18

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Keywords: expectations; monetary policy; federal funds futures; exchange rates;

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References

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  1. Fatum, Rasmus & Hutchison, Michael, 1999. "Is Intervention a Signal of Future Monetary Policy? Evidece from the Federal Funds Futures Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(1), pages 54-69, February.
  2. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
  3. John B. Carlson & Jean M. McIntire & James B. Thomson, 1995. "Federal funds futures as an indicator of future monetary policy: a primer," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 20-30.
  4. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," American Economic Review, American Economic Association, vol. 93(1), pages 38-62, March.
  5. Christopher J. Neely & Lucio Sarno, 2002. "How well do monetary fundamentals forecast exchange rates?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 51-74.
  6. Eichenbaum, Martin & Evans, Charles L, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 110(4), pages 975-1009, November.
  7. Baillie, Richard T & Bollerslev, Tim, 1989. "The Message in Daily Exchange Rates: A Conditional-Variance Tale," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(3), pages 297-305, July.
  8. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
  9. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  10. Gurkaynak, Refet S. & Sack, Brian T. & Swanson, Eric P., 2007. "Market-Based Measures of Monetary Policy Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 201-212, April.
  11. Jeremy Berkowitz & Lorenzo Giorgianni, 1996. "Long-horizon exchange rate predictability?," Finance and Economics Discussion Series 96-39, Board of Governors of the Federal Reserve System (U.S.).
  12. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  13. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
  14. Brian Sack, 2002. "Extracting the expected path of monetary policy from futures rates," Finance and Economics Discussion Series 2002-56, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Bredin, Don & Hyde, Stuart & O'Reilly, Gerard, 2005. "European Monetary Policy Surprises: The Aggregate and Sectoral Stock Market Response," Research Technical Papers 10/RT/05, Central Bank of Ireland.

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