Daily Changes in Fed Funds Futures Prices

This paper explores the properties of daily changes in the prices for near-term fed funds futures contracts. The paper finds these contracts to be excellent predictors of the fed funds rate, and shows that the claim of a nonzero term premium in the short-horizon contracts is more sensitive to outliers than previous research appears to have recognized. I find some statistically significant evidence of serial correlation in the daily changes, but this accounts for only a tiny part of the 1-day movements and there is essentially zero predictability for horizons longer than 1 day. Settlement futures prices for each day appear to incorporate the information embodied in that day's term structure of longer-horizon Treasury securities. Previous employment growth makes a statistically significant contribution to predicting futures price changes, though again this could only account for a tiny part of the daily variance. The paper concludes that futures prices provide a very useful measure of the daily changes in the market's expectation of near-term changes in Fed policy.     

Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models

This paper examines a shift in the dynamics of the term structure of interest rates in the United States during the mid-1980s. We document this shift using standard interest rate regressions and using dynamic, affine, no-arbitrage models estimated for the pre- and post-shift subsamples. The term structure shift largely appears to be the result of changes in the pricing of risk associated with a "level" factor. Using a macro-finance model, we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the Federal Reserve's inflation target as perceived by investors.     

The effect of Fed monetary policy regimes on the US interest rate swap spreads

This paper analyzes the asymmetric impacts of various economic shocks on swap spreads under distinct Fed monetary policy regimes. The results indicate that (a) during periods of aggressive interest rate reductions, slope of the Treasury term structure accounts for a sizeable share of the swap spread variance although default shock is also a major player. (b) On the other hand, liquidity premium is the only contributor to the 2-year swap spread variance in monetary tightening cycles. (c) The impact of default risk varies across both monetary cycles and swap maturities. (d) The effect of interest rate volatility is generally more evident in loosening monetary regimes.     

Models of the yield curve and the curvature of the implied forward rate function

We examine several alternative models of the UK gilt yield curve using daily data for the period 12 July 1996-10 February 2010. We select the best models according to two criteria: low out of sample errors in pricing bonds and low curvature of the implied forward rate curve function. We suggest additions to some of the models that significantly improve their performance. Some of the new models out perform those typically used by the central banks. In particular this paper suggests that the model used by the Canadian Central Bank which both outperforms other models and is particularly easy to estimate, is well suited to the UK gilt market.     

Using Survey Data of Inflation Expectations in the Estimation of Learning and Rational Expectations Models

Does survey data contain useful information for estimating macroeconomic models? We address this question by using survey data of inflation expectations to estimate the New Keynesian model by Smets and Wouters ( 2007 ) and compare its performance under rational expectations and adaptive learning. The survey information serves as an additional moment restriction and helps us to determine the learning agents' forecasting model for inflation. Adaptive learning fares similarly to rational expectations in fitting macro data, but clearly outperforms rational expectations in fitting macro and survey data simultaneously. In other words, survey data contain additional information that is not present in the macro data alone.     

Nonlinear Drift And Stochastic Volatility: An Empirical Investigation Of Short-Term Interest Rate Models

In this article I provide new evidence on the role of nonlinear drift and stochastic volatility in interest rate modeling. I compare various model specifications for the short‐term interest rate using the data from five countries. I find that modeling the stochastic volatility in the short rate is far more important than specifying the shape of the drift function. The empirical support for nonlinear drift is weak with or without the stochastic volatility factor. Although a linear drift stochastic volatility model fits the international data well, I find that the level effect differs across countries.     

Monetary Policy Expectations at the Zero Lower Bound

We show that conventional dynamic term structure models (DTSMs) estimated on recent U.S. data severely violate the zero lower bound (ZLB) on nominal interest rates and deliver poor forecasts of future short rates. In contrast, shadow‐rate DTSMs account for the ZLB by construction, capture the resulting distributional asymmetry of future short rates, and achieve good forecast performance. These models provide more accurate estimates of the most likely path for future monetary policy—including the timing of policy liftoff from the ZLB and the pace of subsequent policy tightening. We also demonstrate the benefits of including macroeconomic factors in a shadow‐rate DTSM when yields are constrained near the ZLB.     

The Liquidity Effect in the Federal Funds Market: Evidence at the Monthly Frequency

In this paper, we argue that much of the research into the link between money and interest rates suffers from misspecification. The measure of money and the measure of interest rates are not always well matched. In examining the transmission of monetary policy, we show that using an appropriate measure of money, Federal Reserve balances, and the appropriate interest rate, the federal funds rate, a clear liquidity effect exists. Furthermore, we explain how a lack of a clear institutional understanding may have contributed to the finding of a "liquidity puzzle" in the past.     

Communication by Central Bank Committee Members: Different Strategies, Same Effectiveness?

The paper assesses the communication strategies of the Federal Reserve, the Bank of England, and the European Central Bank and their effectiveness. We find that the effectiveness of communication is not independent from the decision-making process. The paper shows that the Federal Reserve has been pursuing a highly individualistic communication strategy amid a collegial approach to decision making, while the Bank of England is using a collegial communication strategy and highly individualistic decision making. The European Central Bank (ECB) has chosen a collegial approach both in its communication and in its decision making. Assessing these strategies, we find that predictability of policy decisions and the responsiveness of financial markets to communication are equally good for the Federal Reserve and the ECB. This suggests that there may not be a single best approach to designing a central bank communication strategy.     

The term structure of policy rules

A formula is derived that links the coefficients of the monetary policy rule for the short-term interest rate to the coefficients of the implied affine equations for long-term interest rates. The formula predicts that an increase in the coefficients in the monetary policy rule will lead to an increase in the coefficients in the affine equations. Empirical evidence for such a prediction is provided. The curve of the response coefficients by maturity is also predicted by the formula. The formula's predictive accuracy and its closed form make it a useful tool for studying the policy implications of embedding no-arbitrage affine theories into macro models.     

New Keynesian Macroeconomics and the Term Structure

This article complements the structural New Keynesian macro framework with a no-arbitrage affine term structure model. Whereas our methodology is general, we focus on an extended macro model with unobservable processes for the inflation target and the natural rate of output that are filtered from macro and term structure data. We find that term structure information helps generate large and significant parameters governing the monetary policy transmission mechanism. Our model also delivers strong contemporaneous responses of the entire term structure to various macroeconomic shocks. The inflation target shock dominates the variation in the "level factor" whereas monetary policy shocks dominate the variation in the "slope and curvature factors."     

Monetary Policy and the Cross-Section of Expected Stock Returns

Ample evidence shows that size and book-to-market equity explain significant cross-sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three-factor model that includes beta, size, and book-to-market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex-ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross-sectional returns in a three-factor model that includes the monetary sector.     

The U.S. Treasury yield curve: 1961 to the present

The discount function, which determines the value of all future nominal payments, is the most basic building block of finance and is usually inferred from the Treasury yield curve. It is therefore surprising that researchers and practitioners do not have available to them a long history of high-frequency yield curve estimates. This paper fills that void by making public the Treasury yield curve estimates of the Federal Reserve Board at a daily frequency from 1961 to the present. We use a well-known and simple smoothing method that is shown to fit the data very well. The resulting estimates can be used to compute yields or forward rates for any horizon. We hope that the data, which are posted on the website http://www.federalreserve.gov/pubs/feds/2006 and which will be updated quarterly, will provide a benchmark yield curve that will be useful to applied economists.     

The Federal Reserve’s balance sheet and overnight interest rates: Empirical modeling of exit strategies

This paper provides a comprehensive study of the interplay between the Federal Reserve’s balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves. Treating outright securities holdings of the Federal Reserve as a policy tool, we estimate the effects of unconventional monetary policy on overnight funding rates. Further, we offer the first empirical assessment of the FOMC’s principles of the exit strategy. Assuming a path for removing monetary policy accommodation that is consistent with the FOMC’s exit principles, we project that the federal funds rate increases to 70 basis points by 2016, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.     

The Risk‐Taking Channel of Monetary Policy in the U.S.: Evidence from Corporate Loan Data

To study the presence of a risk‐taking channel in the U.S., we build a comprehensive data set from the syndicated corporate loan market and measure monetary policy using different measures, most notably Taylor (1993) and Romer and Romer (2004) residuals. We identify a negative relation between monetary policy rates and bank risk‐taking, especially in the run up to the 2007 financial crisis. However, this effect is purely supply‐side driven only when using Taylor residuals and an ex ante measure of bank risk‐taking. Our results highlight the sensitivity of the potency of the risk‐taking channel to the measures of monetary policy innovations.     

Flow and stock effects of large-scale treasury purchases: Evidence on the importance of local supply

The Federal Reserve’s 2009 program to purchase $300 billion of US Treasury securities represented an unprecedented intervention in the Treasury market and provides a natural experiment with the potential to shed light on the price elasticities of Treasuries and theories of supply effects in the term structure. Using security-level data on Treasury prices and quantities during the course of this program, we document a ‘local supply’ effect in the yield curve—yields within a particular maturity sector responded more to changes in the amounts outstanding in that sector than to similar changes in other sectors. We find that this phenomenon was responsible for a persistent downward shift in yields averaging about 30 basis points over the course of the program (the “stock effect”). In addition, except at very long maturities, purchase operations caused an average decline in yields in the sector purchased of 3.5 basis points on the days when those operations occurred (the “flow effect”). The sensitivity of our results to security characteristics generally supports a view of segmentation or imperfect substitution within the Treasury market during this time.     

Variations in effects of monetary policy on stock market returns in the past four decades

Stock prices are sensitive to monetary policy. However, the sensitivities are not stable over time. A drastic change in monetary policy can alter effects of monetary policy on stock returns. This study finds that stock prices can be affected by current changes, unexpected changes, or near-future changes in the funds/discount rates, due to different policy goals or targets in different periods. Specifically, this study provides empirical evidence that monetary policy influences the stock market in different ways in the 1960s, the 1970s, the Volcker and Greenspan periods.     

A structural decomposition of the US yield curve

By expanding the macro part of macro-finance models, historical fluctuations in US bond yields turn out to be largely consistent with the rational expectations hypothesis. We estimate a medium-scale macro-finance DSGE model of the term structure to establish this. Our finding contrasts with existing macro-finance models and suggests that their—small-scale or non-structural—perspective on the macroeconomy mutes expectations, thereby underestimating the expectations hypothesis’ potential. Out-of-sample forecasts are competitive with more flexible term structure models. Given the empirical validation, we interpret various episodes through the lens of the model and investigate which structural shocks cause the yield curve to contain information about future growth.     

Purdah—On the Rationale for Central Bank Silence around Policy Meetings

Many central banks share the practice of purdah , a guideline of abstaining from communication around policy meetings. Although seemingly contradicting the virtue of transparency by withholding information precisely when it is sought after intensely, it has been justified on grounds that such communication may create excessive market volatility. This paper assesses the purdah for the Federal Reserve and confirms that financial markets are substantially more sensitive to central bank communication around policy meetings. Short-term interest rates react three to four times more strongly in the purdah before Federal Open Market Committee meetings than otherwise, and volatility increases (compared to a reduction otherwise).