Dynamics of the Federal Funds Target Rate: A Nonstationary Discrete Choice Approach
AbstractWe apply a discrete choice approach to model the empirical behavior of the Federal Reserve in changing the federal funds target rate, the benchmark of short term market interest rates in the US. Our methods allow the explanatory variables to be nonstationary as well as stationary. This feature is particularly useful in the present application as many economic fundamentals that are monitored by the Fed and are believed to affect decisions to adjust interest rate targets display some nonstationarity over time. The empirical model is determined using the PIC criterion (Phillips and Ploberger, 1996; Phillips, 1996) as a model selection device. The chosen model successfully predicts the majority of the target rate changes during the time period considered (1985-2001) and helps to explain strings of similar intervention decisions by the Fed. Based on the model-implied optimal interest rate, our findings suggest that there a lag in the Fed's reaction to economic shocks and that the Fed is more conservative in raising interest rates than in lowering rates.
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Bibliographic InfoPaper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1365.
Length: 35 pages
Date of creation: May 2002
Date of revision:
Publication status: Published in Journal of Applied Econometrics (2004), 19(17): 851-867
Note: CFP 1112.
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Find related papers by JEL classification:
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
- C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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