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The Pavlovian Response of Term Rates to Fed Announcements

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  • Oscar Jorda
  • Selva Demiralp

    (Department of Economics, University of California Davis)

Abstract

The traditional view of the monetary transmission mechanism rests on the premise that the Federal Reserve (Fed) controls the level of the Federal funds rate via open market operations and the liquidity effect. By contrast, this paper argues that the Fed also manipulates the Federal funds rate via public disclosures of the new level of the Federal funds rate target and the ""announcement effect.'''' We define the announcement effect as the portion of interest rate movements associated with public statements on interest rate targets that do not require conventional open market operations for their support. This paper provides evidence on how the Fed uses the liquidity effect in conjunction with the announcement effect to execute monetary policy. In addition, it investigates the implications of the announcement effect on term structure behavior and the rational expectations hypothesis.

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Bibliographic Info

Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 996.

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Length: 47
Date of creation: 15 Jan 2003
Date of revision:
Handle: RePEc:cda:wpaper:99-6

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Keywords: Liquidity Effect; Announcement Effect; Term Structure; Marked Point Process;

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References

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  1. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
  2. McCulloch, Robert & Rossi, Peter E., 1994. "An exact likelihood analysis of the multinomial probit model," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 207-240.
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  5. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
  6. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  7. Bernanke, Ben S. & Mihov, Ilian, 1998. "The liquidity effect and long-run neutrality," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 149-194, December.
  8. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
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  16. Pagan, A.R. & Robertson, J.C., 1994. "Resolving the Liquidity Effect," Papers 277, Australian National University - Department of Economics.
  17. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October.
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Citations

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Cited by:
  1. Kevin Hoover & Oscar Jorda, 2001. "Measuring Systematic Monetary Policy," Working Papers 610, University of California, Davis, Department of Economics.
  2. Andreas Schabert, . "Identifying Monetary Policy Shocks with Changes in Open Market Operations," Working Papers 2003_10, Business School - Economics, University of Glasgow, revised Jun 2003.
  3. Demiralp, Selva & Farley, Dennis, 2005. "Declining required reserves, funds rate volatility, and open market operations," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1131-1152, May.
  4. Michael Woodford, 2001. "Monetary Policy in the Information Economy," NBER Working Papers 8674, National Bureau of Economic Research, Inc.
  5. Selva Demiralp, 2001. "Monetary policy in a changing world: rising role of expectations and the anticipation effect," Finance and Economics Discussion Series 2001-55, Board of Governors of the Federal Reserve System (U.S.).
  6. Gabriel Pérez Quirós & Jorge Sicilia, 2002. "Is the European Central Bank (and the United States Federal Reserve) predictable?," Banco de Espa�a Working Papers 0229, Banco de Espa�a.
  7. Oscar Jorda & Paul Bergin, 2003. "Monetary Policy Coordination: A New Empirical Approach," Working Papers 12, University of California, Davis, Department of Economics.
  8. Sylwia Nowak, 2008. "How Do Public Announcements Affect The Frequency Of Trading In U.S. Airline Stocks?," CAMA Working Papers 2008-38, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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