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Interest Rate Spreads and Forward Guidance

Author

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  • Christian Bredemeier
  • Christoph Kaufmann
  • Andreas Schabert

Abstract

Announcements of future monetary policy rate changes have been found to be imperfectly passed through to various interest rates. We provide evidence for rates of return on less liquid assets to respond by less than, e.g., treasury rates to forward guidance announcements of the US Federal Reserve, suggesting that single-interest-rate models tend to overestimate their macroeconomics effects. We apply a macroeconomic model with interest rate spreads stemming from differential pledgeability of assets, implying that assets provide liquidity services to different extents. Consistent with empirical evidence, announcements of future reductions in the policy rate lead to an increase in liquidity premia. The output effects of forward guidance do not increase with length of the guidance period and are substantially less pronounced than they are predicted to be by a standard New Keynesian model. We thereby provide a solution to the so-called †forward guidance puzzle†.

Suggested Citation

  • Christian Bredemeier & Christoph Kaufmann & Andreas Schabert, 2017. "Interest Rate Spreads and Forward Guidance," Working Paper Series in Economics 96, University of Cologne, Department of Economics.
  • Handle: RePEc:kls:series:0096
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    Cited by:

    1. Pascal Michaillat & Emmanuel Saez, 2021. "Resolving New Keynesian Anomalies with Wealth in the Utility Function," The Review of Economics and Statistics, MIT Press, vol. 103(2), pages 197-215, May.
    2. Diba, Behzad & Loisel, Olivier, 2021. "Pegging the interest rate on bank reserves: A resolution of New Keynesian puzzles and paradoxes," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 230-244.
    3. Christian Bredemeier & Falko Juessen & Andreas Schabert, 2021. "Why Are Fiscal Multipliers Moderate Even Under Monetary Accommodation?," ECONtribute Discussion Papers Series 074, University of Bonn and University of Cologne, Germany.

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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