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Federal Reserve interest rate targeting, rational expectations, and the term structure

  • Glenn D. Rudebusch

The amount of information in the yield curve for forecasting future changes in short rates varies with the maturity of the rates involved. Indeed, spreads between certain long and short rates appear unrelated to future changes in the short rate--contrary to the rational expectations hypothesis of the term structure. This paper estimates a daily model of Federal Reserve interest rate targeting behavior, which, accompanied by the maintained hypothesis of rational expectations, explains the varying predictive ability of the yield curve and elucidates the link between Fed policy and the term structure.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 95-02.

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Date of creation: 1995
Date of revision:
Publication status: Published in Journal of Monetary Economics (April 1995, v. 35 no. 2, p. 245-274)
Handle: RePEc:fip:fedfap:95-02
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  1. Rudebusch, Glenn D, 1992. "Trends and Random Walks in Macroeconomic Time Series: A Re-examination," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(3), pages 661-80, August.
  2. repec:bla:restud:v:58:y:1991:i:3:p:495-514 is not listed on IDEAS
  3. Mishkin, F.S., 1988. "The Information In The Term Structure: Some Further Results," Papers fb-_88-26, Columbia - Graduate School of Business.
  4. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  5. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  6. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  7. Bennett T. McCallum, 1994. "Monetary Policy and the Term Structure of Interest Rates," NBER Working Papers 4938, National Bureau of Economic Research, Inc.
  8. Balduzzi, Pierluigi & Bertola, Giuseppe & Foresi, Silverio, 1997. "A model of target changes and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 223-249, July.
  9. N. Gregory Mankiw & Jeffrey A. Miron, 1990. "Should The Fed Smooth Interest Rates? The Case of Seasonal Monetary Policy," NBER Working Papers 3388, National Bureau of Economic Research, Inc.
  10. Stephen R. Blough, 1994. "Yield curve forecasts of inflation: a cautionary tale," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 3-16.
  11. Ben S. Bernanke & Alan S. Blinder, 1989. "The federal funds rate and the channels of monetary transmission," Working Papers 89-10, Federal Reserve Bank of Philadelphia.
  12. Poole, William, 1982. "Federal Reserve Operating Procedures: A Survey and Evaluation of the Historical Record since October 1979," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 14(4), pages 575-96, November.
  13. 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.
  14. Rudebusch, Glenn D, 1993. "The Uncertain Unit Root in Real GNP," American Economic Review, American Economic Association, vol. 83(1), pages 264-72, March.
  15. Diebold, Francis X & Rudebusch, Glenn D, 1992. "Have Postwar Economic Fluctuations Been Stabilized?," American Economic Review, American Economic Association, vol. 82(4), pages 993-1005, September.
  16. Kenneth A. Froot, 1987. "New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," NBER Working Papers 2363, National Bureau of Economic Research, Inc.
  17. Michael Dotsey & Christopher Otrok, 1995. "The rational expectations hypothesis of the term structure, monetary policy, and time-varying term premia," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 65-81.
  18. Diebold, Francis X & Rudebusch, Glenn D, 1990. "A Nonparametric Investigation of Duration Dependence in the American Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 596-616, June.
  19. Shea, Gary S, 1992. "Benchmarking the Expectations Hypothesis of the Interest-Rate Term Structure: An Analysis of Cointegration Vectors," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 347-66, July.
  20. Timothy Q. Cook & Thomas K. Hahn, 1989. "The credibility of the Wall Street Journal in reporting the timing and details of monetary policy events," Working Paper 89-05, Federal Reserve Bank of Richmond.
  21. repec:tpr:qjecon:v:101:y:1986:i:2:p:211-28 is not listed on IDEAS
  22. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  23. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  24. 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.
  25. Simon, David P., 1989. "Expectations and Risk in the Treasury Bill Market: An Instrumental Variables Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 357-365, September.
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