Abstract
This paper demonstrates a significant depreciation of the dollar in foreign exchange markets to announcements of larger than anticipated monthly U.S. trade deficits over the entire period from early 1985 through late 1988 but differential interest rate responses to this information. Through mid 1986 short term interest rates declined on the announcement of negative trade news which is consistent with monetary easing to depreciate the dollar during this time period so as to narrow the trade gap. For trade announcement surprises after this, through late 1988, interest rates increased across the entire maturity structure. This result suggests a policy reversal by the central bank in response to continued large trade deficit announcements in order to defend the foreign exchange value of the dollar. Yet the continued depreciation of the dollar coupled with rising long term interest rates are consistent with increased risk premia associated with holding dollar denominated assets during this time period.
Published Version
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