Introducing the Kansas City Fed's Measure of Policy Rate Uncertainty (KC PRU)

Monitoring uncertainty around the future path of interest rates can help ensure that monetary policy is transmitting to the economy as intended. Because uncertainty is not directly observable, measuring uncertainty about the future policy rate can be difficult. Previous measures often face two key limitations. First, they may be released with a lag, making them less useful as a timely measure of policy rate uncertainty. Second, they may not be available over a long sample, making it difficult to compare measures of current uncertainty with historical context. In this article, Brent Bundick, A. Lee Smith, and Luca Van der Meer introduce the Kansas City Fed’s Measure of Policy Rate Uncertainty (KC PRU), a timely, market-based measure that can help overcome these limitations. The KC PRU measures one-year-ahead uncertainty using the prices of financial options, which settle based on future short-term interest rates that tend to be highly correlated with the federal funds rate. By combining both historical and newly issued options, they calculate the measure at a daily frequency starting in the late 1980s. Overall, their analysis suggests the KC PRU provides a timely measure of policy rate uncertainty that appears to be consistent with both historical movements and recent macroeconomic developments.