IDEAS home Printed from https://ideas.repec.org/p/cwm/wpaper/31.html
   My bibliography  Save this paper

Monetary Policy, the Bond Market, and Changes in FOMC Communication Policy

Author

Listed:
  • Troy Davig

    () (Federal Reserve Bank of Kansas City)

  • Jeffrey R. Gerlach

    () (Department of Economics, College of William and Mary)

Abstract

Using high-frequency data in a Markov-switching framework, we identify states that imply different responses of the yield curve to unexpected changes in the federal funds target. Empirical estimates reveal a low-volatility state where long-term bonds respond significantly, and in a predictable manner, to unexpected changes in the federal funds target. An alternative state exists with higher volatility, where unexpected changes in the federal funds target raise the short-end of the yield curve, but have no significant effect on the long-end. The low-volatility state for long-term bonds occurs from September 1995 to May 1999 and again from March 2000 to January 2002. The timing of the switches between the two states for long-term bonds coincides with changes in FOMC communication policy - though not all changes in communications policy induce a switch.

Suggested Citation

  • Troy Davig & Jeffrey R. Gerlach, 2006. "Monetary Policy, the Bond Market, and Changes in FOMC Communication Policy," Working Papers 31, Department of Economics, College of William and Mary.
  • Handle: RePEc:cwm:wpaper:31
    as

    Download full text from publisher

    File URL: http://economics.wm.edu/wp/cwm_wp31.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Refet S. Gürkaynak & Andrew T. Levin & Eric T. Swanson, 2006. "Does inflation targeting anchor long-run inflation expectations? evidence from long-term bond yields in the U.S., U.K., and Sweden," Working Paper Series 2006-09, Federal Reserve Bank of San Francisco.
    2. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, June.
    3. Jeffery D. Amato & Stephen Morris & Hyun Song Shin, 2002. "Communication and Monetary Policy," Oxford Review of Economic Policy, Oxford University Press, vol. 18(4), pages 495-503.
    4. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 61-82, Suppl. De.
    5. Ulf Soderstrom & Tore Ellingsen, 2004. "Why are long rates sensitive to monetary policy?," Computing in Economics and Finance 2004 31, Society for Computational Economics.
    6. Troy Davig & Jeffrey R. Gerlach, 2006. "State-Dependent Stock Market Reactions to Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
    7. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November.
    8. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
    9. John H. Boyd & Jian Hu & Ravi Jagannathan, 2005. "The Stock Market's Reaction to Unemployment News: Why Bad News Is Usually Good for Stocks," Journal of Finance, American Finance Association, vol. 60(2), pages 649-672, April.
    10. Demiralp, Selva & Jorda, Oscar, 2004. "The Response of Term Rates to Fed Announcements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 387-405, June.
    11. Refet S Gürkaynak & Brian Sack & Eric Swanson, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
    12. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Real-Time Price Discovery in Stock, Bond and Foreign Exchange Markets," PIER Working Paper Archive 04-028, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 28 Jun 2004.
    13. Hansen, Bruce E, 1996. "Erratum: The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(2), pages 195-198, March-Apr.
    14. Berument, Hakan & Froyen, Richard T., 2006. "Monetary policy and long-term US interest rates," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 737-751, December.
    15. Robert B. Davies, 2002. "Hypothesis testing when a nuisance parameter is present only under the alternative: Linear model case," Biometrika, Biometrika Trust, vol. 89(2), pages 484-489, June.
    16. Beechey, Meredith, 2004. "Excess Sensitivity and Volatility of Long Interest Rates: The Role of Limited Information in Bond Markets," Working Paper Series 173, Sveriges Riksbank (Central Bank of Sweden).
    17. Faust, Jon & Rogers, John H. & Wang, Shing-Yi B. & Wright, Jonathan H., 2007. "The high-frequency response of exchange rates and interest rates to macroeconomic announcements," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1051-1068, May.
    18. William Poole & Robert H. Rasche, 2003. "The impact of changes in FOMC disclosure practices on the transparency of monetary policy: are markets and the FOMC better "synched"?," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 1-10.
    19. Cook, Timothy & Hahn, Thomas, 1989. "The effect of changes in the federal funds rate target on market interest rates in the 1970s," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 331-351, November.
    20. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
    21. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    22. McQueen, Grant & Roley, V Vance, 1993. "Stock Prices, News, and Business Conditions," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 683-707.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Monetary Policy; Bond Market; Markov-Switching; Central Bank Communications;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cwm:wpaper:31. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Daifeng He) or (Alfredo Pereira). General contact details of provider: http://edirc.repec.org/data/decwmus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.