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Perfecting the Market's Knowledge of Monetary Policy

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  • William Poole
  • Robert Rasche

Abstract

The rational expectations revolution made clear that a complete macro model requires a specification of the government's economic policy. We argue that monetary policy should be conducted in such a way that the market can predict policy actions. An implication of market success in predicting policy actions is that interest rates move ahead of the policy actions, and such a timing relationship may appear to some as the central bank following the market instead of leading it. Another implication of the market predicting policy actions is that nominal interest rate changes provide no useful information to the central bank about the strength of aggregate demand or inflationary expectations. Finally, the failure of the market to predict policy actions reflects a problem that needs to be addressed. We explore the theoretical implications of a monetary policy that is completely specified and perfectly understood by the market. We construct a bare-bones model to illustrate the key concepts. Finally, we conduct an empirical investigation of these issues, especially in the context of monetary policy since 1988 when the establishment of the federal funds future market made available well-defined market information on expectations about Fed policy actions.

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File URL: http://hdl.handle.net/10.1023/A:1026555225089
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Bibliographic Info

Article provided by Springer in its journal Journal of Financial Services Research.

Volume (Year): 18 (2000)
Issue (Month): 2 (December)
Pages: 255-298

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Handle: RePEc:kap:jfsres:v:18:y:2000:i:2:p:255-298

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Web page: http://www.springerlink.com/link.asp?id=102934

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  1. Perman, Roger & Scouller, John, 1999. "Business Economics," OUP Catalogue, Oxford University Press, number 9780198775249.
  2. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  3. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  4. William Poole, 1999. "Synching, not sinking, the markets," Speech 77, Federal Reserve Bank of St. Louis.
  5. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  6. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, July.
  7. John C. Robertson & Daniel L. Thornton, 1997. "Using federal funds futures rates to predict Federal Reserve actions," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 45-53.
  8. Antulio N. Bomfim & Vincent R. Reinhart, 2000. "Making news: financial market effects of Federal Reserve disclosure practices," Finance and Economics Discussion Series 2000-14, Board of Governors of the Federal Reserve System (U.S.).
  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  10. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
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