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

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  • Pierluigi Balduzzi
  • Giuseppe Bertola
  • Silverio Foresi

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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Bibliographic Info

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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Publication status: published as Balduzzi, Pierluigi, Giuseppe Bertola and Silvero Foresi. "A Model Of Target Changes And The Term Structure Of Interest Rates," Journal of Monetary Economics, 1997, v39(2,Jul), 223-249.
Handle: RePEc:nbr:nberwo:4347

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  19. Pierluigi Balduzzi & Giuseppe Bertola & Silverio Foresi, 1993. "A Model of Target Changes and the Term Structure of Interest Rates," NBER Working Papers 4347, National Bureau of Economic Research, Inc.
  20. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
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  24. 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.
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