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A model of target changes and the term structure of interest rates

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  • Balduzzi, Pierluigi
  • Bertola, Giuseppe
  • Foresi, Silverio

Abstract

We explore the effects of official targeting policy on the term-structure of nominal interest rates, adapting relevant insights from theoretical work on "peso problems" to account for realistic infrequency of target changes. Our analysis of daily U.S. interest rates and newly available historical targets provides an interpretation for persistent spreads between short-term money-market rates and overnight fed-funds targets, and for the poor performance of expectations-hypothesis tests: it is the policy-induced component of fed funds dynamics that appears to be erroneously anticipated by the market. Still, allowance for serial correlation in target changes makes it possible to extract from interest-rate data an expected-knoll series which is quite consistent with the assumptions of the model, indicating that some features of the interest-rate-targeting process are incorporated by market expectations.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 39 (1997)
Issue (Month): 2 (July)
Pages: 223-249

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Handle: RePEc:eee:moneco:v:39:y:1997:i:2:p:223-249

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Timothy Cook & Thomas Hahn, 1990. "Interest rate expectations and the slope of the money market yield curve," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 3-26.
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  3. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  4. Pierluigi Balduzzi & Giuseppe Bertola & Silverio Foresi, 1993. "A Model of Target Changes and the Term Structure of Interest Rates," NBER Working Papers 4347, National Bureau of Economic Research, Inc.
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  14. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 211-28, May.
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  23. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
  24. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  25. Lindberg, H. & Svensson, L.E. & Soderlind, P., 1991. "Devaluation Expectations: the Swedish Krona 1982-1991," Papers 495, Stockholm - International Economic Studies.
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