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Monetary policy in a changing world: rising role of expectations and the anticipation effect

  • Selva Demiralp

The Federal Reserve (Fed) has maintained a general trend toward increased transparency and gradualism. This paper investigates the implications of these historical developments for the anticipation of monetary policy actions and adjustment of interest rates. In a theoretical framework, we establish the Fed's ability to manipulate overnight rates via an "anticipation" effect. The anticipation effect is defined as interest rate adjustments that take place prior to a policy announcement (or prior to when the complementary open market operations associated with that policy action take place) due to market's improved ability to predict future policy actions. Our empirical results document that most market rates adjust to anticipated policy actions prior to the actual announcement. Because the market responds to policy announcements instantly, the Trading Desk does not need to act immediately after the target change and can wait until the market incorporates the new information that comes with the policy announcement.

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File URL: http://www.federalreserve.gov/pubs/feds/2001/200155/200155pap.pdf
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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-55.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-55
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  1. Peter R. Fisher & Spence Hilton, 1999. "Highlights of domestic open market operations during 1998," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 217-235.
  2. Selva Demiralp & Òscar Jordà, 2001. "The Pavlovian response of term rates to Fed announcements," Finance and Economics Discussion Series 2001-10, Board of Governors of the Federal Reserve System (U.S.).
  3. 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.
  4. Leonardo Bartolini & Giuseppe Bertola & Alessandro Prati, 2000. "Day-to-day monetary policy and the volatility of the federal funds interest rate," Staff Reports 110, Federal Reserve Bank of New York.
  5. Richard G. Anderson & Robert H. Rasche, 2001. "Retail sweep programs and bank reserves, 1994-1999," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 51-72.
  6. Peter R. Fisher & Gerald D. Cohen, 1997. "Open market operations during 1996," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jul, pages 565-574.
  7. James D. Hamilton & Oscar Jorda, . "A model for the federal funds rate target," Department of Economics 99-07, California Davis - Department of Economics.
  8. Selva Demiralp & Òscar Jordà, 2002. "The announcement effect: evidence from open market desk data," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 29-48.
  9. Athanasios Orphanides, 2001. "Expectations, open market operations, and changes in the federal funds rate (commentary)," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 33-58.
  10. 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.
  11. Feinman, Joshua N, 1993. "Estimating the Open Market Desk's Daily Reaction Function," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 231-47, May.
  12. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
  13. William Poole, 2001. "Expectations," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 1-10.
  14. Laurence H. Meyer, 2001. "Does money matter?," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-16.
  15. John B. Taylor, 2001. "Expectations, open market operations, and changes in the federal funds rate," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 33-58.
  16. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
  17. Cheryl L. Edwards, 1997. "Open market operations in the 1990s," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 859-874.
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