Each week the Federal Reserve announces preliminary estimates of the previous week's average daily level of the narrowly defined monetary aggregate, M1, in the H.6 statistical release. Standard theory would indicate that given efficient financial markets, rates and prices on financial assets should adjust to only the unanticipated component of the money supply announcement.; Initial studies examined the adjustment of nominal interest rates to the money supply announcement but the exact nature of the announcement effect was not identified. The theoretical model and empirical work of this dissertation attempt to resolve the ambiguity surrounding the analysis of the nature of the announcement effect. The theoretical model extends previous work by explicitly incorporating prices and price expectations. By examining interest rate and foreign exchange rate adjustment to the announcement, explicit information on the nature of the effect is learned. In response to an announced unanticipated increase in the level of money balances, for example, the resulting simultaneous increase in domestic interest rates and the appreciation of the domestic currency reveal that the announcement effect is predominantly a real interest rate effect. A simultaneous increase in the inflation premium can not be ruled out, however, if the market anticipates that the policy response is incomplete. In such a situation there is an anticipated decreased flow of reserves to the system per period, but not of sufficient amount to entirely offset the unanticipated increase in the money supply. Short-term rate adjustment would be dominated by a real interest rate adjustment while longer term rates would include a substantial inflation premium adjustment.; A final point is that some evidence of foreign exchange market inefficiency is observed as exchange rates are shown to adjust significantly to the anticipated component of the money supply announcement.
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