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A note on the expectations hypothesis at the founding of the Fed

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  • Clemens J. M. Kool
  • Daniel L. Thornton

Abstract

One of the most influential tests of the expectations hypothesis is Mankiw and Miron (1986), who found that the spread between the long-term and short-term rates provided predictive power for the short-term rate before the Fed's founding but not after. They suggested that the failure of the expectations hypothesis after the Fed's founding was due to the Fed's practice of smoothing short-term interest rates. We show that their finding that the expectations hypothesis fares better prior to the Fed's founding is due to the fact that the test they employ tends to generate results that are more favorable to the expectations hypothesis during periods when there is extreme volatility in the short-term rate. (Earlier version titled: The expectations theory and the founding of the Fed: another look at the evidence)

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2000-004.

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Date of creation: 2003
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Publication status: Published in Journal of Banking and Finance, December 2004, 28(12), pp. 3055-68
Handle: RePEc:fip:fedlwp:2000-004

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Keywords: Interest rates ; Rational expectations (Economic theory) ; Federal Reserve System - History;

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References

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  1. Mankiw, N Gregory & Miron, Jeffrey A & Weil, David N, 1990. "The Adjustment of Expectations to a Change in Regime: Reply," American Economic Review, American Economic Association, vol. 80(4), pages 977-79, September.
  2. Fishe, Raymond P H & Wohar, Mark, 1990. "The Adjustment of Expectations to a Change in Regime: Comment," American Economic Review, American Economic Association, vol. 80(4), pages 968-76, September.
  3. N. Gregory Mankiw & Jeffrey A. Miron & David N. Weil, 1987. "The Adjustment of Expectations to a Change in Regime: A Study of the Founding of the Federal Reserve," NBER Working Papers 2124, National Bureau of Economic Research, Inc.
  4. Geert Bekaert & Robert J. Hodrick, 2000. "Expectations Hypotheses Tests," NBER Working Papers 7609, National Bureau of Economic Research, Inc.
  5. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(2), pages 211-28, May.
  6. 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, Cowles Foundation for Research in Economics, Yale University 667, Cowles Foundation for Research in Economics, Yale University.
  7. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 57(6), pages 1361-1401, November.
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Citations

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Cited by:
  1. Thornton, Daniel L., 2005. "Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2541-2556, October.
  2. Sarno, Lucio & Thornton, Daniel L. & Valente, Giorgio, 2007. "The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(01), pages 81-100, March.
  3. Bulkley, George & Harris, Richard D.F. & Nawosah, Vivekanand, 2011. "Revisiting the expectations hypothesis of the term structure of interest rates," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1202-1212, May.
  4. Daniel L. Thornton, 2012. "Evidence on the portfolio balance channel of quantitative easing," Working Papers, Federal Reserve Bank of St. Louis 2012-015, Federal Reserve Bank of St. Louis.
  5. Menzies Gordon Douglas & Zizzo Daniel John, 2009. "Inferential Expectations," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 9(1), pages 1-27, December.
  6. Daniel L. Thornton, 2003. "Testing the expectations hypothesis: some new evidence for Japan," Working Papers, Federal Reserve Bank of St. Louis 2003-033, Federal Reserve Bank of St. Louis.
  7. repec:use:tkiwps:1205 is not listed on IDEAS
  8. Massimo Guidolin & Daniel L. Thornton, 2010. "Predictions of short-term rates and the expectations hypothesis," Working Papers, Federal Reserve Bank of St. Louis 2010-013, Federal Reserve Bank of St. Louis.
  9. Modena, Matteo, 2008. "The term structure and the expectations hypothesis: a threshold model," MPRA Paper 9611, University Library of Munich, Germany.
  10. M. Hadzi-Vaskov & C.J.M. Kool, 2006. "The importance of interest rate volatility in empirical tests of uncovered interest parity," Working Papers, Utrecht School of Economics 06-16, Utrecht School of Economics.
  11. Clemens J.M. Kool & Daniel L. Thornton, 2012. "How effective is central bank forward guidance?," Working Papers, Federal Reserve Bank of St. Louis 2012-063, Federal Reserve Bank of St. Louis.

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