High money growth raises expected inflation

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Reference no: EM131162023

Every week the Federal Reserve announces how quickly money supply grew in the week ending ten days previously. Economist have noticed that when the announced increase in the money supply is greater than expected, nominal interest rates rise just after announcement; they fall when the market learn the money supply grew more slowly than expected. There are two competing explanation for this phenomena.

First unexpectedly high money growth raises expected inflation and thus raises nominal interest rates.

Second, unexpectedly high money growth leads the market to expect the future Fed action to reduce money supply, causing a decrease in the amount of deposits supplied to the public by bank but not increase in expected inflation. How would you use data from foreign exchange market to decide between these two hypotheses?

Reference no: EM131162023

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