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A note on the expectations hypothesis at the founding of the Fed

  • Clemens J. M. Kool
  • Daniel L. Thornton

One of the most influential tests of the expectations hypothesis is Mankiw and Miron (1986), who found that the spread between the long-term and short-term rates provided predictive power for the short-term rate before the Fed's founding but not after. They suggested that the failure of the expectations hypothesis after the Fed's founding was due to the Fed's practice of smoothing short-term interest rates. We show that their finding that the expectations hypothesis fares better prior to the Fed's founding is due to the fact that the test they employ tends to generate results that are more favorable to the expectations hypothesis during periods when there is extreme volatility in the short-term rate. (Earlier version titled: The expectations theory and the founding of the Fed: another look at the evidence)

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2000-004.

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Date of creation: 2003
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Publication status: Published in Journal of Banking and Finance, December 2004, 28(12), pp. 3055-68
Handle: RePEc:fip:fedlwp:2000-004
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  1. 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.
  2. Mankiw, N Gregory & Miron, Jeffrey A & Weil, David N, 1987. "The Adjustment of Expectations to a Change in Regime: A Study of the Founding of the Federal Reserve," American Economic Review, American Economic Association, vol. 77(3), pages 358-74, June.
  3. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers 338, Princeton, Department of Economics - Econometric Research Program.
  4. Fishe, Raymond P H & Wohar, Mark, 1990. "The Adjustment of Expectations to a Change in Regime: Comment," American Economic Review, American Economic Association, vol. 80(4), pages 968-76, September.
  5. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Cowles Foundation Discussion Papers 667, Cowles Foundation for Research in Economics, Yale University.
  6. Mankiw, N Gregory & Miron, Jeffrey A & Weil, David N, 1990. "The Adjustment of Expectations to a Change in Regime: Reply," American Economic Review, American Economic Association, vol. 80(4), pages 977-79, September.
  7. Geert Bekaert, 2001. "Expectations Hypotheses Tests," Journal of Finance, American Finance Association, vol. 56(4), pages 1357-1394, 08.
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