The effect of monetary policy actions on exchange rates under interest-rate targeting

We specify a theoretical model of the exchange-rate response to U.S. moneta ry policy actions that is capable of explaining a wide range of recent empi rical results. We show that the response pattern of spot and expected futur e exchange rates depends on the predictability of Federal Reserve actions, the persistence of shocks to the economy, and the reaction of foreign centr al banks to the US monetary policy shock. We also show that the movements o f spot and expected future exchange rates in anticipation of a monetary pol icy change can outweigh the immediate responses at the time of the change. (C) 2000 Elsevier Science Ltd. All rights reserved.