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The information content of discount rate announcements: what's behind the announcement effect?

  • Daniel L. Thornton

A considerable volume of research shows that asset prices respond to changes in the Federal Reserve's discount rate. While several competing hypotheses have been advanced to explain the market's response to discount rate announcements, comparatively little effort has been made to differentiate among alternative hypotheses. The result is an abundance of evidence establishing that asset prices respond to discount rate announcements, but little if any agreement about why markets respond. This article attempts to fill a void in the literature by pointing out how competing hypotheses differ and by constructing tests explicitly designed to differentiate among competing explanations. The evidence suggest that the market's reaction to discount rate changes is purely an announcement effect, i.e., a reaction to new information contained in the announcement, that the direct effect of discount rate changes on market rates is nil, that the announcement effect is invariant to the Federal Reserve's operating procedure and that, generally speaking, changes in the discount rate do not signal a change in monetary policy. The announcement effect appears to vary with both the nature and extent of the information that the announcement of a discount rate change is believed to contain.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1994-032.

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Date of creation: 1996
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Publication status: Published in Journal of Banking and Finance, January 1998
Handle: RePEc:fip:fedlwp:1994-032
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  1. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," NBER Working Papers 3974, National Bureau of Economic Research, Inc.
  2. 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.
  3. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  4. Lombra, Raymond E & Torto, Raymond G, 1977. "Discount Rate Changes and Announcement Effects," The Quarterly Journal of Economics, MIT Press, vol. 91(1), pages 171-76, February.
  5. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Review, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  6. Benjamin M. Friedman & Kenneth N. Kuttner, 1993. "Economic Activity and the Short-term Credit Markets: An Analysis of Prices and Quantities," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 193-284.
  7. Anil K. Kashyap & Jeremy C. Stein & David W. Wilcox, 1991. "Monetary policy and credit conditions: evidence from the composition of external finance," Finance and Economics Discussion Series 154, Board of Governors of the Federal Reserve System (U.S.).
  8. Michael J. Dueker, 1992. "The response of market interest rates to discount rate changes," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 78-91.
  9. Garfinkel, Michelle R & Thornton, Daniel L, 1995. "The Information Content of the Federal Funds Rate: Is It Unique?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 838-47, August.
  10. Thornton, Daniel L, 1994. "Why Do T-Bill Rates React to Discount Rate Changes?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 839-50, November.
  11. Waud, Roger N, 1970. "Public Interpretation of Federal Reserve Discount Rate Changes: Evidence on the 'Announcement Effect'," Econometrica, Econometric Society, vol. 38(2), pages 231-50, March.
  12. V. Vance Roley & Rick Troll, 1984. "The impact of discount rate changes on market interest rates," Economic Review, Federal Reserve Bank of Kansas City, issue Jan, pages 27-39.
  13. Smirlock, Michael J & Yawitz, Jess B, 1985. " Asset Returns, Discount Rate Changes, and Market Efficiency," Journal of Finance, American Finance Association, vol. 40(4), pages 1141-58, September.
  14. Dallas S. Batten & Daniel L. Thornton, 1985. "The discount rate, interest rates and foreign exchange rates: an analysis with daily data," Review, Federal Reserve Bank of St. Louis, issue Feb, pages 22-30.
  15. Hakkio, Craig S. & Pearce, Douglas K., 1992. "Discount rate policy under alternative operating procedures: An empirical investigation," International Review of Economics & Finance, Elsevier, vol. 1(1), pages 55-72.
  16. John Coleman & Christian Gilles & Pamela Labadie, 1993. "Identifying monetary policy with a model of the federal funds rate," Finance and Economics Discussion Series 93-24, Board of Governors of the Federal Reserve System (U.S.).
  17. James A. Clouse, 1994. "Recent developments in discount window policy," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 965-977.
  18. Tinsley, Peter A, et al, 1982. "Policy Robustness: Specification and Simulation of a Monthly Money Market Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 14(4), pages 829-56, November.
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