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Market-based measures of monetary policy expectations

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Author Info

  • Refet S. Gürkaynak
  • Brian Sack
  • Eric Swanson

Abstract

A number of recent papers have used different financial market instruments to measure near-term expectations of the federal funds rate and the high-frequency changes in these instruments around FOMC announcements to measure monetary policy shocks. This paper evaluates the empirical success of a variety of financial market instruments in predicting the future path of monetary policy. All of the instruments we consider provide forecasts that are clearly superior to those of standard time series models at all of the horizons considered. Among financial market instruments, we find that federal funds futures dominate all the other securities in forecasting monetary policy at horizons out to six months. For longer horizons, the predictive power of many of the instruments we consider is very similar. In addition, we present evidence that monetary policy shocks computed using the current-month federal funds futures contract are influenced by changes in the timing of policy actions that do not influence the expected course of policy beyond a horizon of about six weeks. We propose an alternative shock measure that captures changes in market expectations of policy over slightly longer horizons.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2006-04.

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Date of creation: 2006
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Handle: RePEc:fip:fedfwp:2006-04

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Keywords: Monetary policy ; Federal funds rate ; Financial markets;

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References

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  1. Söderström, Ulf, 1999. "Predicting monetary policy using federal funds future prices," Working Paper Series 85, Sveriges Riksbank (Central Bank of Sweden).
  2. Monika Piazzesi & Eric T. Swanson, 2006. "Futures prices as risk-adjusted forecasts of monetary policy," Working Paper Series 2006-23, Federal Reserve Bank of San Francisco.
  3. Refet S. Gürkaynak, 2005. "Using federal funds futures contracts for monetary policy analysis," Finance and Economics Discussion Series 2005-29, Board of Governors of the Federal Reserve System (U.S.).
  4. Jon Faust & Eric Swanson & and Jonathan H. Wright, 2002. "Identifying vars based on high frequency futures data," International Finance Discussion Papers 720, Board of Governors of the Federal Reserve System (U.S.).
  5. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, 06.
  6. Downing, Chris & Oliner, Stephen, 2007. "The term structure of commercial paper rates," Journal of Financial Economics, Elsevier, vol. 83(1), pages 59-86, January.
  7. Christopher A. Sims & Tao Zha, 1996. "Bayesian methods for dynamic multivariate models," Working Paper 96-13, Federal Reserve Bank of Atlanta.
  8. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2002. "Market-based measures of monetary policy expectations," Finance and Economics Discussion Series 2002-40, Board of Governors of the Federal Reserve System (U.S.).
  9. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November.
  10. Bernanke, Ben S. & Mihov, Ilian, 1995. "Measuring Monetary Policy," Economics Series 10, Institute for Advanced Studies.
  11. William Poole & Robert Rasche, 2000. "Perfecting the Market's Knowledge of Monetary Policy," Journal of Financial Services Research, Springer, vol. 18(2), pages 255-298, December.
  12. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  13. Joel T. Krueger & Kenneth N. Kuttner, 1995. "The Fed funds futures rate as a predictor of Federal Reserve policy," Working Paper Series, Macroeconomic Issues 95-4, Federal Reserve Bank of Chicago.
  14. 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.
  15. Lange, Joe & Sack, Brian & Whitesell, William, 2003. " Anticipations of Monetary Policy in Financial Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(6), pages 889-909, December.
  16. John H. Cochrane & Monika Piazzesi, 2002. "The Fed and Interest Rates: A High-Frequency Identification," NBER Working Papers 8839, National Bureau of Economic Research, Inc.
  17. John B. Carlson & Jean M. McIntire & James B. Thomson, 1995. "Federal funds futures as an indicator of future monetary policy: a primer," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 20-30.
  18. Rudebusch, Glenn D, 1998. "Do Measures of Monetary Policy in a VAR Make Sense?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 907-31, November.
  19. Brunner, Allan D, 2000. "On the Derivation of Monetary Policy Shocks: Should We Throw the VAR Out with the Bath Water?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(2), pages 254-79, May.
  20. Charles L. Evans, 1998. "Real-time Taylor rules and the federal funds futures market," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 44-55.
  21. Bomfim, Antulio N., 2003. "Pre-announcement effects, news effects, and volatility: Monetary policy and the stock market," Journal of Banking & Finance, Elsevier, vol. 27(1), pages 133-151, January.
  22. Robertson, John C & Tallman, Ellis W, 2001. "Improving Federal-Funds Rate Forecasts in VAR Models Used for Policy Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(3), pages 324-30, July.
  23. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
  24. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  25. Clemon, Robert T & Winkler, Robert L, 1986. "Combining Economic Forecasts," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(1), pages 39-46, January.
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