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The Pavlovian response of term rates to Fed announcements

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  • Selva Demiralp
  • Òscar Jordà

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 in term structure behavior and the rational expectations hypothesis.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-10.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-10

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Keywords: Liquidity (Economics) ; Federal funds rate ; Monetary policy;

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  1. Jerry A. Hausman & Andrew W. Lo & A. Craig MacKinlay, 1991. "An Ordered Probit Analysis of Transaction Stock Prices," NBER Working Papers 3888, National Bureau of Economic Research, Inc.
  2. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Review, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  3. 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.
  4. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
  5. Dueker, Michael, 1999. "Conditional Heteroscedasticity in Qualitative Response Models of Time Series: A Gibbs-Sampling Approach to the Bank Prime Rate," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(4), pages 466-72, October.
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  14. Ben S. Bernanke & Ilian Mihov, 1998. "The Liquidity Effect and Long-Run Neutrality," NBER Working Papers 6608, National Bureau of Economic Research, Inc.
  15. Thornton, Daniel L., 2001. "The Federal Reserve's operating procedure, nonborrowed reserves, borrowed reserves and the liquidity effect," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1717-1739, September.
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  17. 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.
  18. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  19. Lawrence J. Christiano, 1995. "Resolving the liquidity effect: commentary," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 55-62.
  20. Eichengreen, Barry & Watson, Mark W & Grossman, Richard S, 1985. "Bank Rate Policy under the Interwar Gold Standard: A Dynamic Probit Model," Economic Journal, Royal Economic Society, vol. 95(379), pages 725-45, September.
  21. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
  22. 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.
  23. 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.
  24. V. Vance Roley & Gordon H. Sellon, Jr., 1998. "Market reaction to monetary policy nonannouncements," Research Working Paper 98-06, Federal Reserve Bank of Kansas City.
  25. Jeffrey M. Wrase, 1998. "Is the Fed being swept out of (monetary) control?," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-12.
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Cited by:
  1. Schabert, Andreas, 2005. "Identifying monetary policy shocks with changes in open market operations," European Economic Review, Elsevier, vol. 49(3), pages 561-577, April.
  2. Kevin D. Hoover & Òscar Jordà, 2001. "Measuring systematic monetary policy," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 113-144.
  3. Paul R. Bergin & Oscar Jorda, . "Monetary Policy Coordination: A New Empirical Approach," Department of Economics 01-02, California Davis - Department of Economics.
  4. Selva Demiralp & Dennis Farley, 2003. "Declining required reserves, funds rate volatility, and open market operations," Finance and Economics Discussion Series 2003-27, Board of Governors of the Federal Reserve System (U.S.).
  5. Pérez Quirós, Gabriel & Sicilia, Jorge, 2002. "Is the European Central Bank (and the United States Federal Reserve) predictable?," Working Paper Series 0192, European Central Bank.
  6. Michael Woodford, 2001. "Monetary policy in the information economy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-370.
  7. 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.
  8. 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.).

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