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The Impact of Monetary Policy on the Exchange Rate: A Study Using Intraday Data

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Author Info

  • Jonathan Kearns

    (Reserve Bank of Australia)

  • Phil Manners

    (Reserve Bank of Australia)

Abstract

This paper uses intraday data to estimate the effect of changes in monetary policy on the exchange rate. We use an event study with carefully selected sample periods for four countries (Australia, Canada, New Zealand and the United Kingdom) to ensure that the change in monetary policy is exogenous to the exchange rate. Intraday data allow us to use a short event window, which improves the accuracy of estimates, and demonstrates that the change in policy is rapidly incorporated into the exchange rate. On average, an unanticipated tightening of 25 basis points is found to appreciate the exchange rate by around 0.35 per cent, with estimates for the individual countries ranging from ¼–½ of a per cent. The estimation indicates that monetary policy changes account for only a small part of the observed variability of exchange rates in these countries. We also find that changes in monetary policy have substantially different effects on the exchange rate depending on how they alter expectations regarding future policy. Surprises that cause expectations of future policy to be revised by the full amount of the surprise are found to have a larger impact on the exchange rate (around 0.4 per cent) than surprises that only bring forward an anticipated change in policy and do not change expectations of future policy (around 0.2 per cent).

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2005-02.

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Date of creation: Apr 2005
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Handle: RePEc:rba:rbardp:rdp2005-02

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Keywords: exchange rates; monetary policy; intraday data;

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References

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  1. Monika Piazzesi & Eric T. Swanson, 2006. "Futures prices as risk-adjusted forecasts of monetary policy," Working Paper Series 2006-23, Federal Reserve Bank of San Francisco.
  2. Danielsson, J. & Payne, R., 2002. "Real trading patterns and prices in spot foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 21(2), pages 203-222, April.
  3. 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.
  4. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  5. Jeromin Zettelmeyer, 2000. "The Impact of Monetary Policy on the Exchange Rate - Evidence from Three Small Open Economies," IMF Working Papers 00/141, International Monetary Fund.
  6. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
  7. Ben S. Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Staff Reports 174, Federal Reserve Bank of New York.
  8. Faust, Jon & Rogers, John H., 2003. "Monetary policy's role in exchange rate behavior," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1403-1424, October.
  9. Jon Faust & John H. Rogers & Eric Swanson & Jonathan H. Wright, 2003. "Identifying the Effects of Monetary Policy Shocks on Exchange Rates Using High Frequency Data," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1031-1057, 09.
  10. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  11. 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.
  12. David Archer & Andy Brookes & Michael Reddell, 1999. "A cash rate system for implementing monetary policy," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 62, March.
  13. Goodhart, Charles A. E. & Payne, Richard G., 1996. "Microstructural dynamics in a foreign exchange electronic broking system," Journal of International Money and Finance, Elsevier, vol. 15(6), pages 829-852, December.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Blogs review: The Events Study methodology
    by ? in Bruegel blog on 2012-10-08 09:51:26
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Cited by:
  1. Hilde C. Bjørnland, 2006. "Monetary Policy and the Illusionary Exchange Rate Puzzle," Computing in Economics and Finance 2006 45, Society for Computational Economics.
  2. Xinsheng Lu & Ying Zhou & Mingting Kou, 2013. "The Impact of Monetary Policy Surprises on Australian Financial Futures Markets," Working Papers 2013-01, Auckland University of Technology, Department of Economics.
  3. Rosa, Carlo, 2011. "The high-frequency response of exchange rates to monetary policy actions and statements," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 478-489, February.
  4. Carlo Rosa, 2012. "How "unconventional" are large-scale asset purchases? The impact of monetary policy on asset prices," Staff Reports 560, Federal Reserve Bank of New York.
  5. Bernd Hayo & Matthias Neuenkirch, 2012. "Domestic Or U.S. News: What Drives Canadian Financial Markets?," Economic Inquiry, Western Economic Association International, vol. 50(3), pages 690-706, 07.
  6. "Hilde C." "Bjørnland", 2008. "Monetary Policy and Exchange Rate Interactions in a Small Open Economy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 110(1), pages 197-221, 03.
  7. Rosa, Carlo, 2013. "Market efficiency broadcasted live: ECB code words and euro exchange rates," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 167-178.
  8. Aliyu, Shehu Usman Rano, 2011. "Reactions of stock market to monetary policy shocks during the global financial crisis: the Nigerian case," MPRA Paper 35581, University Library of Munich, Germany, revised 28 Dec 2011.
  9. Ivrendi, Mehmet & Yildirim, Zekeriya, 2013. "Monetary policy shocks and macroeconomic variables: Evidence from fast growing emerging economies," Economics Discussion Papers 2013-61, Kiel Institute for the World Economy.
  10. Pennings, Steven & Ramayandi, Arief & Tang, Hsiao Chink, 2011. "The Impact of Monetary Policy on Financial Markets in Small Open Economies: More or Less Effective During the Global Financial Crisis?," Working Papers on Regional Economic Integration 72, Asian Development Bank.
  11. Hilde C. Bjørnland, 2009. "Monetary policy and exchange rate overshooting: Dornbusch was right after all," Working Paper 2009/09, Norges Bank.
  12. Emanuel Kohlscheen, 2011. "The Impact of Monetary Policy on the Exchange Rate: puzzling evidence from three emerging economies," Working Papers Series 259, Central Bank of Brazil, Research Department.

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