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

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

SCCIE Working Paper No. 05-24

This version: November 25, 2005

Rasmus Fatum*
School of Business
University of Alberta

Edmonton, Alberta
Canada, T6G 2R6

Abstract:     This paper shows that exchange rates respond to only the surprise component of

an actual US monetary policy change and that failure to disentangle the surprise component from
the actual monetary policy change can lead to an underestimation of the impact of monetary
policy, or even to a false acceptance of the hypothesis that monetary policy has no impact on
exchange rates. This finding implies that there is a need for reexamining the empirical analyses
of asset price responses to macro news that do not isolate the unexpected component of news
from the expected element. In addition, we add to the debate on how quickly exchange rates
respond to news by showing that the exchange rates under study absorb monetary policy
surprises within the same day as the news are announced.

Key words: Expectations, Monetary Policy, Federal Funds Futures, Exchange Rates.

JEL Classifications: E52, F31, G14.

* Corresponding author. This research was begun while Fatum was visiting the University of
Copenhagen. Both authors gratefully acknowledge financial support from separate Social
Sciences of Humanities Research Council of Canada (SSHRC) grants and a joint University of
Alberta School of Business CIBS grant. We are most grateful to the authors of Galati, Melick
and Micu (2005) for help with the macroeconomic news data. We thank Michael Hutchison,
Henrik Jensen and Anthony Saunders for very helpful comments.

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