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Monetary policy actions and long-term interest rates

  • V. Vance Roley
  • Gordon H. Sellon, Jr.
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    It is generally believed that monetary policy actions are transmitted to the economy through their effect on market interest rates. According to this standard view, a restrictive monetary policy by the Federal Reserve pushes up both short-term and long-term interest rates, leading to less spending by interest-sensitive sectors of the economy such as housing, consumer durable goods, and business fixed investment. Conversely, an easier policy results in lower interest rates that stimulate economic activity. Unfortunately, empirical studies and the observed behavior of interest rates appear to challenge the standard view of the monetary transmission mechanism and raise questions about the effectiveness of monetary policy.> Roley and Sellon attempt to reconcile theory and reality by reexamining the connection between monetary policy and long-term interest rates. Using a framework that emphasizes the importance of market expectations of future monetary policy actions, the authors argue that the relationship between policy actions and long-term rates is likely to vary over the business cycle as financial market participants alter their views on the persistence of policy actions. Accordingly, the standard view of the monetary transmission mechanism appears to provide an overly simplistic view of the policy process. In addition, by capturing the tendency of market rates to anticipate policy actions, the authors find a larger response of long-term rates to monetary policy actions than reported in previous research.

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    File URL: http://www.kansascityfed.org/publicat/econrev/pdf/4q95role.pdf
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    Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

    Volume (Year): (1995)
    Issue (Month): Q IV ()
    Pages: 73-89

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    Handle: RePEc:fip:fedker:y:1995:i:qiv:p:73-89:n:v.80no.4
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