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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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References

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  1. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  2. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
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  5. 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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  8. James D. Hamilton, 1996. "Measuring the liquidity effect," Working Papers in Applied Economic Theory 96-06, Federal Reserve Bank of San Francisco.
  9. 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.
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  19. 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.
  20. Cook, Timothy & Hahn, Thomas, 1989. "The effect of changes in the federal funds rate target on market interest rates in the 1970s," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 331-351, November.
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Citations

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Cited by:
  1. Oscar Jorda & Paul Bergin, 2003. "Monetary Policy Coordination: A New Empirical Approach," Working Papers 12, University of California, Davis, Department of Economics.
  2. Kevin D. Hoover & Òscar Jordà, 2001. "Measuring systematic monetary policy," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 113-144.
  3. 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.
  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. 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.
  7. Schabert, Andreas, 2005. "Identifying monetary policy shocks with changes in open market operations," European Economic Review, Elsevier, vol. 49(3), pages 561-577, April.
  8. 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.

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