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

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

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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Suggested Citation

  • Kool, Clemens J. M. & Thornton, Daniel L., 2004. "A note on the expectations hypothesis at the founding of the Fed," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3055-3068, December.
  • Handle: RePEc:eee:jbfina:v:28:y:2004:i:12:p:3055-3068
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    1. Geert Bekaert, 2001. "Expectations Hypotheses Tests," Journal of Finance, American Finance Association, vol. 56(4), pages 1357-1394, August.
    2. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 211-228.
    3. Mankiw, N Gregory & Miron, Jeffrey A & Weil, David N, 1987. "The Adjustment of Expectations to a Change in Regime: A Study of the Founding of the Federal Reserve," American Economic Review, American Economic Association, vol. 77(3), pages 358-374, June.
    4. 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 968-976, September.
    5. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
    6. 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.
    7. 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 977-979, September.
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    Cited by:

    1. Menzies Gordon Douglas & Zizzo Daniel John, 2009. "Inferential Expectations," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-27, December.
    2. Daniel L. Thornton, 2004. "Testing the expectations hypothesis: some new evidence for Japan," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 21-40.
    3. 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.
    4. Kool, Clemens J. M. & Thornton, Daniel L., 2015. "How Effective Is Central Bank Forward Guidance?," Review, Federal Reserve Bank of St. Louis, vol. 97(4), pages 303-322.
    5. Massimo Guidolin & Daniel L. Thornton, 2010. "Predictions of short-term rates and the expectations hypothesis," Working Papers 2010-013, Federal Reserve Bank of St. Louis.
    6. M. Hadzi-Vaskov & C.J.M. Kool, 2006. "The Importance of Interest Rate Volatility in Empirical Tests of Uncovered Interest Parity," Working Papers 06-16, Utrecht School of Economics.
    7. 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.
    8. Matteo Modena, 2008. "The Term Structure and the Expectations Hypothesis: a Threshold Model," Working Papers 2008_36, Business School - Economics, University of Glasgow.
    9. Daniel L. Thornton, 2005. "Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates," Working Papers 2004-010, Federal Reserve Bank of St. Louis.
    10. 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.
    11. Daniel L. Thornton, 2012. "Evidence on the portfolio balance channel of quantitative easing," Working Papers 2012-015, Federal Reserve Bank of St. Louis.

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