Monetary Policy News and Exchange Rate Responses: Do Only Surprises Matter?

control variables. For both models the b₁ coefficient is insignificant while the b₂ coefficient is positive
and significant at the 99 percent level, suggesting that the expected component of a monetary policy
change has no impact on the exchange rate while the unexpected component of a tightening (loosening) of
US monetary policy is associated with an immediate appreciation (depreciation) of the USD vis-à-vis the
DEM. The coefficient estimates imply that an unexpected one percentage point (one hundred basis
points) change in the target rate is associated with a 2.7 percent same-day change in the exchange rate.
Or, equivalently, an unexpected 25 basis point change in the target rate is associated with a 0.675 percent
same-day change in the exchange rate.

The last two columns of Table 2 show the estimation results from regressing same-day changes in
the DEM/USD exchange rate on the actual change in the Fed funds target rate (i.e. the sum of the
expected and the unexpected components), as described in equation (2). Again, the first of these two
columns shows the results when including all the news control variables while the second column shows
the results without any news control variables included as none of these appear to be significant.

None of the two models show any significant effects of a monetary policy change when the
Kuttner-decomposition is not used, i.e. when the unexpected component is “hidden” in the actual change.

This finding shows that assessing the impact of monetary policy changes on exchange rates
without taking into account expectations in order to isolate the surprise component would lead to a wrong
conclusion, namely that monetary policy changes do not matter for exchange rates. We see this as an
important result because it highlights the necessity of focusing on the surprise component of news rather
than on the actual news (i.e. the sum of the surprise and the expected component) itself.

Turning to the delayed effects and the issue of how quickly the exchange rate absorbs monetary
policy news, Table 3 shows the coefficient estimate associated with the unexpected component of the Fed
funds target rate changes for each of the first 15 lead-models described in equation (3) and, in order to
facilitate an easy comparison between same-day and delayed effects, repeats the same-day coefficient also
shown in the second column of Table 2. In other words, each row of Table 3 is associated with a separate

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