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Monetary policy in a changing world: rising role of expectations and the anticipation effect

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  • Selva Demiralp

Abstract

The Federal Reserve (Fed) has maintained a general trend toward increased transparency and gradualism. This paper investigates the implications of these historical developments for the anticipation of monetary policy actions and adjustment of interest rates. In a theoretical framework, we establish the Fed's ability to manipulate overnight rates via an "anticipation" effect. The anticipation effect is defined as interest rate adjustments that take place prior to a policy announcement (or prior to when the complementary open market operations associated with that policy action take place) due to market's improved ability to predict future policy actions. Our empirical results document that most market rates adjust to anticipated policy actions prior to the actual announcement. Because the market responds to policy announcements instantly, the Trading Desk does not need to act immediately after the target change and can wait until the market incorporates the new information that comes with the policy announcement.

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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 2001-55.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-55

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Keywords: Monetary policy ; Interest rates ; Federal funds rate;

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References

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  1. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
  2. Alessandro Prati & Giuseppe Bertola & Leonardo Bartolini, 2000. "Day-To-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," IMF Working Papers 00/206, International Monetary Fund.
  3. 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.
  4. Richard G. Anderson & Robert H. Rasche, 2001. "Retail sweep programs and bank reserves, 1994-1999," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 51-72.
  5. 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.
  6. 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.
  7. Athanasios Orphanides, 2001. "Expectations, open market operations, and changes in the federal funds rate (commentary)," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 33-58.
  8. James D. Hamilton & Oscar Jorda, 2002. "A Model of the Federal Funds Rate Target," Journal of Political Economy, University of Chicago Press, vol. 110(5), pages 1135-1167, October.
  9. Selva Demiralp & Òscar Jordà, 2001. "The Pavlovian response of term rates to Fed announcements," Finance and Economics Discussion Series 2001-10, Board of Governors of the Federal Reserve System (U.S.).
  10. Selva Demiralp & Oscar Jorda, . "The Announcement Effect: Evidence from Open Market Desk Data," Department of Economics 01-04, California Davis - Department of Economics.
  11. Cheryl L. Edwards, 1997. "Open market operations in the 1990s," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 859-874.
  12. John B. Taylor, 2001. "Expectations, open market operations, and changes in the federal funds rate," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 33-58.
  13. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
  14. Peter R. Fisher & Gerald D. Cohen, 1997. "Open market operations during 1996," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jul, pages 565-574.
  15. William Poole, 2001. "Expectations," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 1-10.
  16. Laurence H. Meyer, 2001. "Does money matter?," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-16.
  17. Peter R. Fisher & Spence Hilton, 1999. "Highlights of domestic open market operations during 1998," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 217-235.
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Cited by:
  1. 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.
  2. Benjamin Friedman & Kenneth Kuttner, 2010. "Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?," Department of Economics Working Papers 2010-03, Department of Economics, Williams College.
  3. Carin van der Cruijsen & Sylvester Eijffinger, 2007. "The economic impact of central bank transparency: a survey," DNB Working Papers 132, Netherlands Central Bank, Research Department.
  4. Neuenkirch, Matthias, 2013. "Central bank transparency and financial market expectations: The case of emerging markets," Economic Systems, Elsevier, vol. 37(4), pages 598-609.
  5. Neuenkirch, Matthias, 2012. "Managing financial market expectations: The role of central bank transparency and central bank communication," European Journal of Political Economy, Elsevier, vol. 28(1), pages 1-13.
  6. Ehrmann, Michael & Fratzscher, Marcel, 2005. "Transparency, disclosure and the federal reserve," Working Paper Series 0457, European Central Bank.

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