The effect of unanticipated money on the money and foreign exchange markets

Abstract

A number of studies have attempted to determine why unanticipated increases in the money supply are positively correlated with money market interest rates by examining the response of the foreign exchange market to unanticipated changes in the money stock. They have found a significant positive relationship between unanticipated increases in the money supply and the foreign exchange value of the dollar and have interpreted this as evidence for the ‘anticipated-liquidity-effect’ hypothesis. However, these results support this hypothesis only if both markets respond simultaneously to unanticipated changes in money. This paper examines the cross-market consistency of the response using six bilateral exchange rates and the Treasury bill rate, all measured over a narrow time interval. The results show that, in general, these markets do not respond simultaneously to money announcements.