The behavior of market interest rates when information is incomplete

Conclusions This paper has attempted to show how participants in financial markets, in the face of incomplete information about the supply of and demand for money, might go about formulating expectations of future interest rates in making market-clearing decisions. In particular, it was seen that information about the current excess demand for money, extracted from the current interest rate, could be used in formulating these expectations.In studying the behavior of the resulting market-clearing interest rate, two key conclusions emerged. First, relative to a full-in-formation market-clearing rate, where money supply and money demand were assumed observable, the market-clearing interest rate under signal extraction resulted in a biased response. Second, the bias was found to be related to the rates at which the disturbances to money demand and money supply dissipated. This suggested a role for monetary policy in reducing this bias. But, conversely, this also showed that monetary policy could be a source of volatility of market-clearing interest rates, relative to their full-information values.