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The U. S. monetary policy regime, interest differentials and dollar exchange rate risk premia

  • Michael T. Belongia
  • Mack Ott

It is commonly believed that the Federal Reserve targeted money growth directly and allowed greater variation in interest rates during the October 1979-October 1982 period. Other things the same, this policy regime would be expected to increase the risk premium on the dollar exchange rate relative to a regime that attempted to reduce variations in the interest rate. We find that risk premia apparently did increase during the regime of M1 targeting. This implied that failure to recognize the effects of changes in Fed policy is a source of specification error in exchange rate models.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1987-009.

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Date of creation: 1987
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Publication status: Published in Journal of International Money and Finance, March 1989, 8(1), pp. 137-45
Handle: RePEc:fip:fedlwp:1987-009
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  1. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
  2. Frankel, Jeffrey A & Hardouvelis, Gikas A, 1985. "Commodity Prices, Money Surprises and Fed Credibility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(4), pages 425-38, November.
  3. R. Dornbusch, 1975. "Exchange Rate Dynamics," Working papers 167, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Rudiger Dornbusch, 1980. "Exchange Rate Risk and the Macroeconomics of Exchange Rate Determination," NBER Working Papers 0493, National Bureau of Economic Research, Inc.
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