Conventional wisdom holds that lowering a home country's interest rate relative to another's will depreciate the domestic currency. We document that, at business‐cycle frequencies, U.S. forward guidance monetary policy easings had the opposite effect during the Great Recession. We attribute this effect to calendar‐based forward guidance that signaled economic weakness, resulting in a “flight‐to‐safety” effect and lower expected U.S. inflation. We also document cross‐currency heterogeneity: a surprise U.S. rate cut induced a larger appreciation of the dollar against currencies that typically depreciate more when the world economy is contracting. We build a model that can reconcile these findings.

We disprove the exchange rate macroeconomic disconnect puzzle by showing that macroeconomic news can explain most variation in exchange rates at monthly and quarterly frequencies, accounting for up to 91 percent of the quarterly exchange rate variation during US recessions and 65 percent over all periods. The main driver of the reconnect is exchange rates responding to past news—a result inconsistent with the theory of uncovered interest rate parity under full information rational expectations (UIP-FIRE). We discuss theoretical models that can explain this surprising result, including models featuring currency risk premia, regulatory or institutional frictions, or deviation from FIRE.

Inflation expectations are key determinants of economic activity and are central to the current policy debate about whether inflation expectations will remain anchored in the face of recent pandemic-related increases in inflation. This article explores evidence of inattention by constructing two novel and direct measures of consumers’ inattention, and documents greater attention when inflation is high. This relationship can explain a substantial portion of the flattening of the Phillips curve and also suggests the possibility of upward attention-price spirals.