Monetary actions, intervention, and exchange rates : a re-examination of the empirical relationships using federal funds rate target data

The results of recent empirical studies on the relationships among Federal Reserve monetary-policy actions, U.S. interventions in currency markets, and exchange rates are re-examined. Changes in the Federal Reserve's federal funds rate target as measure of monetary-policy actions are used. Then the relations using federal funds rate target changes only in periods in which the Federal Reserve used the federal funds rate to implement monetary policy are estimated. The results suggest that the immediate responses of exchange rates to U.S. monetary policy actions are statistically and economically significant in a majority of cases. This result differs from those reported recently using VAR methodologies. Moreover, when the spot and forward exchange-rate responses are combined, the authors were not able to reject the overshooting hypothesis in seven of eight instances. In contrast, recent VAR studies estimate exchange-rate response patterns inconsistent with overshooting. The interaction between U.S. interventions and Federal Reserve monetary policy actions are also re-examined. In this case, results consistent with recent studies were obtained. In particular, the authors cannot reject either the policy-signaling or the leaning-against-the-wind hypotheses of intervention effects. Finally, it was found by the authors that the estimates of exchange-rate responses to federal funds rate target changes are virtually unaffected when they control for central-bank interventions.