Monetary Policy vs. Foreign Exchange Rate: A Statistical Analysis

Abstract

The purpose of this paper is to examine the economic impact of the Fed’s rate cuts on foreign exchange movements. Using secondary data, the paper estimates the lagged effects of the changes in money supply due to the rate cuts on the foreign exchange rates between the US dollar and the Japanese Yen ($/¥), British Pounds ($/£), and the euro ($/€), respectively. Since the impact of monetary policy tends to have a time lag, as suggested by Hall and Taylor, the study segments the measurements in six months intervals (6 months form the cut, 12 months from the cut, 18 months from the cut and 24 months from the cut).  The relationship between the changes in money supply and potential impact on foreign exchange rate movements will be investigated using the Pearson Product-Moment Correlation coefficients (PPMCC) as well as Spearman’s Rank Correlation coefficients (SRCC, the nonparametric alternative to the PPMCC).  Then, a hypothesis test will be conducted to determine whether the correlation between the Federal Reserve’s stimulating monetary policy and foreign exchange rate movements is significant.