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Anticipations of monetary policy in financial markets

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  • Joe Lange
  • Brian Sack
  • William Whitesell
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    Abstract

    In recent years, financial markets appear better able to anticipate FOMC policy changes. Beginning in the late 1980s and early 1990s, longer-term interest rates and futures rates have tended to incorporate movements in the federal funds rate several months in advance, in contrast to the largely contemporaneous response typically observed before that time. After identifying these emerging trends, the paper parses the enhanced predictability into a component that can be attributed to the autoregressive behavior of the funds rate and a non-autoregressive component. The paper considers institutional developments in FOMC policy making that may have contributed to each of these components, including gradualism in adjusting the federal funds rate target and transparency regarding the setting of the target and future policy intentions.

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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 2001-24.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedgfe:2001-24

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

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    References

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    1. 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.
    2. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 211-28, May.
    3. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Cowles Foundation Discussion Papers 667, Cowles Foundation for Research in Economics, Yale University.
    4. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
    5. Hardouvelis, Gikas A, 1988. " The Predictive Power of the Term Structure during Recent Monetary Regimes," Journal of Finance, American Finance Association, vol. 43(2), pages 339-56, June.
    6. Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1996. "On Biases in Tests of the Expecations Hypothesis of the Term Structure Of Interest Rates," NBER Technical Working Papers 0191, National Bureau of Economic Research, Inc.
    7. Longstaff, Francis A., 2000. "The term structure of very short-term rates: New evidence for the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 58(3), pages 397-415, December.
    8. Frederic S. Mishkin, 1988. "The Information in the Term Structure: Some Further Results," NBER Working Papers 2575, National Bureau of Economic Research, Inc.
    9. Timothy Cook & Thomas Hahn, 1990. "Interest rate expectations and the slope of the money market yield curve," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 3-26.
    10. Feinman, Joshua N, 1993. "Estimating the Open Market Desk's Daily Reaction Function," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 231-47, May.
    11. Fuhrer, Jeffrey C, 1996. "Monetary Policy Shifts and Long-Term Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1183-1209, November.
    12. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July.
    13. Antulio N. Bomfim & Vincent R. Reinhart, 2000. "Making news: financial market effects of Federal Reserve disclosure practices," Finance and Economics Discussion Series 2000-14, Board of Governors of the Federal Reserve System (U.S.).
    14. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
    15. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
    16. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
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    Cited by:
    1. Sophocles N. Brissimis & Nicholas S. Magginas, 2004. "Forward-Looking Information in VAR Models and the Price Puzzle," Working Papers 10, Bank of Greece.
    2. 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.
    3. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
    4. Michael Woodford, 2005. "Central-bank communication and policy effectiveness," Discussion Papers 0506-07, Columbia University, Department of Economics.
    5. Michael Woodford, 2001. "Monetary policy in the information economy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-370.
    6. Don Bredin & Caroline Gavin & Gerard O Reilly, 2003. "The Influence of Domestic and International Interest Rates on the ISEQ," The Economic and Social Review, Economic and Social Studies, vol. 34(3), pages 249–265.
    7. J. Benson Durham, 2001. "The effect of monetary policy on monthly and quarterly stock market returns: cross-country evidence and sensitivity analyses," Finance and Economics Discussion Series 2001-42, Board of Governors of the Federal Reserve System (U.S.).
    8. Jeff Moore & Richard Austin, 2002. "The behavior of federal funds futures prices over the monetary policy cycle," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 45-61.
    9. Junttila, Juha, 2002. "Forecasting the macroeconomy with current financial market information: Europe and the United States," Research Discussion Papers 2/2002, Bank of Finland.
    10. Luiz de Mello & Diego Moccero, 2007. "Monetary Policy and Macroeconomic Stability in Latin America: The Cases of Brazil, Chile, Colombia and Mexico," OECD Economics Department Working Papers 545, OECD Publishing.
    11. Gordon H. Sellon, Jr., 2002. "The changing U.S. financial system : some implications for the monetary transmission mechanism," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-35.
    12. Shu Wu, 2008. "Monetary Policy And Long-Term Interest Rates," Contemporary Economic Policy, Western Economic Association International, vol. 26(3), pages 398-408, 07.
    13. Adrienne Kearney & Raymond Lombra, 2003. "Fed funds futures and the news," Atlantic Economic Journal, International Atlantic Economic Society, vol. 31(4), pages 330-337, December.

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