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Why do T-bill rates react to discount rate changes?

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  • Daniel L. Thornton

Abstract

This paper investigates the hypothesis suggested by Cook and Hahn (1988) that the T-bill rates respond to the announcement of discount rate changes because the market takes discount rate changes to be a signal that the Fed has changed its target for the federal funds rate. Re-Interpreting Cook and Hahn's empirical evidence and using theirs and an alternative methodology, we show that the evidence cannot differentiate their hypothesis from a number of others that have been suggested in the literature. We further find that there is no difference in the relative magnitude or timing of the response during periods when the Fed was directly targeting the funds rate or using a "fuzzy" funds rate target. This result suggests that the market does not simply interpret discount rate changes as a signal that the Fed has changed its target for the funds rate.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1992-004.

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Date of creation: 1992
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Publication status: Published in Journal of Money, Credit, and Banking, November 1994
Handle: RePEc:fip:fedlwp:1992-004

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Keywords: Discount;

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  1. Poole, William, 1991. "Interest rates and the conduct of monetary policy : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 34(1), pages 31-39, January.
  2. Phillips, Peter C B & Hansen, Bruce E, 1990. "Statistical Inference in Instrumental Variables Regression with I(1) Processes," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(1), pages 99-125, January.
  3. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 34(1), pages 7-30, January.
  4. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  5. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  6. Smirlock, Michael J & Yawitz, Jess B, 1985. " Asset Returns, Discount Rate Changes, and Market Efficiency," Journal of Finance, American Finance Association, American Finance Association, vol. 40(4), pages 1141-58, September.
  7. Fama, Eugene F., 1986. "Term premiums and default premiums in money markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 17(1), pages 175-196, September.
  8. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, Econometric Society, vol. 48(4), pages 817-38, May.
  9. Cook, Timothy & Hahn, Thomas, 1988. "The Information Content of Discount Rate Announcements and Their Effect on Market Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 20(2), pages 167-80, May.
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Cited by:
  1. Kaketsis, Asimakis & Sarantis, Nicholas, 2006. "The effects of monetary policy changes on market interest rates in Greece: An event study approach," International Review of Economics & Finance, Elsevier, Elsevier, vol. 15(4), pages 487-504.
  2. Michael Dueker & Daniel L. Thornton, 1994. "Asymmetry in the prime rate and firms' preference for internal finance," Working Papers, Federal Reserve Bank of St. Louis 1994-017, Federal Reserve Bank of St. Louis.
  3. Galindo, Arturo J. & Maloney, William F., 2002. "Second moments in speculative attack models: panel evidence," Journal of International Economics, Elsevier, vol. 56(1), pages 97-129, January.
  4. Choi, Woon Gyu, 1999. "Estimating the Discount Rate Policy Reaction Function of the Monetary Authority," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 14(4), pages 379-401, July-Aug..
  5. Thornton, Daniel L., 2004. "The Fed and short-term rates: Is it open market operations, open mouth operations or interest rate smoothing?," Journal of Banking & Finance, Elsevier, vol. 28(3), pages 475-498, March.
  6. Gasbarro, Dominic & Monroe, Gary S., 2004. "The impact of monetary policy candidness on Australian financial markets," Journal of Multinational Financial Management, Elsevier, Elsevier, vol. 14(1), pages 35-46, February.
  7. Daniel L. Thornton, 1996. "The information content of discount rate announcements: what's behind the announcement effect?," Working Papers, Federal Reserve Bank of St. Louis 1994-032, Federal Reserve Bank of St. Louis.

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