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A Model of Target Changes and the Term Structure of Interest Rates

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Author Info
Pierluigi Balduzzi
Giuseppe Bertola
Silverio Foresi

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Abstract

We explore the effects of official targeting policy on the term-structure of nominal interest rates, adapting relevant insights from theoretical work on "peso problems" to account for realistic infrequency of target changes. Our analysis of daily U.S. interest rates and newly available historical targets provides an interpretation for persistent spreads between short-term money-market rates and overnight fed-funds targets, and for the poor performance of expectations-hypothesis tests: it is the policy-induced component of fed funds dynamics that appears to be erroneously anticipated by the market. Still, allowance for serial correlation in target changes makes it possible to extract from interest-rate data an expected-knoll series which is quite consistent with the assumptions of the model, indicating that some features of the interest-rate-targeting process are incorporated by market expectations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4347.

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Date of creation: Apr 1993
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Handle: RePEc:nbr:nberwo:4347

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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  1. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May. [Downloadable!] (restricted)
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  2. Giuseppe Bertola & Lars E.O. Svensson, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," NBER Working Papers 3576, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Ben S. Bernanke, 1990. "On the predictive power of interest rates and interest rate spreads," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-68.
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  4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July. [Downloadable!] (restricted)
  5. Rose, Andrew K & Svensson, Lars E O, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," CEPR Discussion Papers 552, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. repec:fip:fedreq:y:1990:i:sep:p:3-26:n:v.76no.5 is not listed on IDEAS
  8. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond. [Downloadable!]
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  9. John Y. Campbell, 1987. "Money Announcements, the Demand for Bank Reserves and the Behavior of the Federal Funds Rate Within the Statement Week," NBER Working Papers 1806, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Blackwell Publishing, vol. 58(3), pages 495-514, May. [Downloadable!] (restricted)
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