Exchange rates.

• Author: Ito, Takatoshi

Exchange Rates

Takatoshi Ito

Since the Plaza Agreement of September 1985, the exchange rates of the major industrial countries have changed dramatically. The dollar depreciated against the yen and the mark by more than 60 percent in the six months following the Plaza Agreement. The dollar's decline continued, although at a slower pace, throughout 1986 and 1987. In 1988, fluctuations in exchange rates decreased significantly but 1989 has been another volatile year.

What kinds of information can trigger large changes in the exchange rate? Why is the volatility apparently clustered in particular periods? How do expectations among traders change when there are large movements in exchange rates, and do their expectations affect the path of the exchange rate? To help answer these questions about exchange rate dynamics, researchers turn to both intradaily data and survey data on exchange rate expectations.

Intradaily Exchange Rate Dynamics: News Announcements, 1980-5

If the foreign exchange market is "efficient," then any movement of the exchange rate should reflect the arrival of new information or "news." For example, an announcement of an unexpected increase in the money supply should affect the exchange rate. In my research, I considered how exchange rates responded to important news about money supply, inflation, and industrial production. Working backward, I also recorded the days (and hours) when large changes in the exchange rate occurred, and then tried to identify the news behind these large jumps.

Because of the time difference between Japan and the United States, the hours of the Tokyo and New York foreign exchange markets do not overlap. Thus, it is possible to distinguish exchange rate movements caused by Tokyo news from those caused by New York news. V. Vance Roley and I exploit this idea by examining the responses of the exchange rate to announcements of the money supply, the inflation rate, and the industrial production index in the United States and Japan.(1) If the market is efficient, there should be a response within minutes after an announcement. We show that when the Federal Reserve pursued a money supply target, from October 1979 to October 1982, the U.S. money supply announcement had a significant effect on the exchange rate. Unexpected increases in the money supply created an expectation that the money supply would be curtailed in the coming months, so that the interest rate, and consequently the dollar, would have to...