The impact of large-scale asset purchases on the S&P 500 index,long-term interest rates and unemployment

After the bankruptcy of Lehman Brothers in September 2008 and the financial panic that ensued, the Federal Reserve moved rapidly to reduce the federal funds rate to .25%. It was quickly judged that additional measures were needed to stabilize the US economy. Beginning in December 2008, the Federal Reserve Bank initiated three rounds of unconventional monetary policies known as quantitative easing (QE). These policies were intended to reduce long-term interest rates when the short-term federal funds rates had reached the zero lower bound and could not become negative. It was argued that the lowering of longer-term interest rates would help the stock market and thus the wealth of consumers. This article carefully investigates three hypotheses: QE impacting long-term interest rates, QE impacting the stock market and QE impacting unemployment using a Markov regime switching methodology. We conclude that QE has contributed significantly to increases in the stock market but less significantly to long-term interest rate and unemployment.     

A model of the federal funds market

Summary This paper develops a stochastic general equilibrium model of the federal funds market that incorporates non-Fisherian effects on interest rates stemming from both supply and demand shocks to reserves. Such a model may reconcile the widespread belief in a liquidity effect of money supply shocks with the difficulty many researchers have had in finding empirical support for such an effect. The model also cautions against interpreting the observed negative correlation between the federal funds rate and innovations to nonborrowed reserves as empirical confirmation of the ability of the Federal Reserve to lower short-term real interest rates.This paper should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or its staff. We gratefully acknowledge lengthy discussions and correspondence with V. V. Chari, Marty Eichenbaum, and especially Larry Christiano, that helped to clarify many issues. We were told many institutional details by Jim Clouse and Josh Feinman, and we received many helpful comments from David Altig, Michael Dotsey, and participants at the conference on Recent Research on the Liquidity Effect of Monetary Policy, 1993, Federal Research Bank of Cleveland, the conference on Recent Macroeconomic Research: Lessons for Policymaking, 1993, Federal Reserve Bank of Atlanta and the conference on Operating Procedures and the Conduct of Monetary Policy, 1992, Federal Reserve Bank of St. Louis.     

MONETARY POLICY AND LONG-TERM INTEREST RATES

Movements in long-term interest rates Granger-cause movements in the target federal funds rate, but not vice versa, during 1990–2001. This implies that changes in the monetary policy stance, as measured by the target rate, are predicted by the bond market. Moreover, even innovations to the target rate have little effect on long-term interest rates. The policy instrument seems to be responding to information that is already impounded in the bond market. In sharp contrast, during an earlier period, changes in the target federal funds rate are mostly unanticipated by the bond market, and innovations to the policy target have a large and significant effect on long-term interest rate. ( JEL E52, E43)     

How has empirical monetary policy analysis in the U.S. changed after the financial crisis?

During the Great Recession, the Federal Reserve lowered the federal funds rate nearly to zero and began using unconventional monetary policy. A fed funds rate near zero is no longer a proper representation of policy. Thus, empirical models of monetary policy cannot be estimated as usual. We use a linear empirical model to investigate whether alternative instruments such as the balance sheet or shadow rates can replace the fed funds rate to capture unconventional policy. Our objective is to determine whether adding to or replacing the policy instrument can preserve linearity or whether one must allow structural breaks. We include data for both normal and unconventional periods and find that shadow rates preserve linearity better than using a bounded federal funds rate alone, adding the balance sheet, or adding long rates. When short rates are bounded, shadow rates produce similar responses to the unbounded period and alleviate the need for structural breaks. [JEL codes: E43, E44, E52] Keywords: zero lower bound, affine term structure.     

Central bank reserve management: Aggregate targets and interest payments on reserves

Tindall and Spencer [1997] presented a dynamic stochastic theory of borrowed reserves that explained the observed nonlinear relationship between borrowing and the spread between the federal funds rate and the discount rate. It showed that borrowed reserves are a function of deposit variation. This paper extends that research, providing a general dynamic model of all key bank reserve aggregates. Nearly all reserve aggregates, which can be used as operating targets by the Federal Reserve, are subject to the influence of deposit variation and are nonlinearly related to the spread between the federal funds rate and the discount rate, complicating their use as targets. Additionally, it is found that the Federal Reserve's proposal to pay interest on bank reserves could generate substantial distortions in reserve aggregate behavior where interest is paid on excess reserves as well as required reserves, effectively resulting in potentially large discount-window policing problems.     

The Australian Economy in 2019–20: Slower Growth,Record Low Interest Rates and a Changing Housing Landscape

Economic activity in Australia slowed considerably in 2018–19, with domestic demand growth halving and unemployment rising. Consistent with the slowdown, both consumer and wage inflation have remained weak. A synchronised growth slow-down was observed across major economies, to some extent underpinned by the on-going US–China trade war. Central banks have responded to weak growth by cutting rates. The US Federal Reserve cut its target for the federal funds rate three times in 2019, as did Australia. To date, record low Australian interest rates have been associated with additional housing-related debt and asset price appreciation.     

The impact of federal funds target changes on interest rate volatility

This paper empirically investigates the 1-day response of interest rate volatility to a federal funds target rate change over the period 1989–2003. Federal funds futures data are used to distinguish between anticipated and unanticipated changes in the funds rate target. Interest rate volatility is modeled as an EGARCH process. The volatility response to an unanticipated Fed policy action is relatively large in size and highly significant for short-term interest rates. However, interest rates at long maturities are found to be responsive to target rate changes, even if they are anticipated, when estimations take into account of structural change in association with the Fed's policy disclosure beginning in 1994, as well as asymmetrical effects between monetary easing and tightening.     

The interbank market during a crisis

The autumn of 1998 provides a setting in which to test the performance of the interbank market during a potential financial crisis. This period witnessed Russia's effective default on its sovereign bonds and the near collapse of the hedge fund Long-Term Capital Management. Despite these negative shocks to bank capital and increased uncertainty in financial markets, the federal funds market still effectively channeled liquidity to those institutions in need at rates consistent with Federal Reserve intentions. Further, risk premiums on overnight lending were largely unaffected and lending volumes increased, suggesting that the federal funds market performed well during this period.     

Why are credit card rates sticky?

Summary This paper investigates credit card rate stickiness using a screening model of consumer credit markets. In recent years, while the cost of funds has fallen, credit card rates have remained stubbornly high, spurring legislators to consider imposing interest rate ceilings on credit card rates. The model incorporates asymmetric information between consumers and banks, regarding consumers' future incomes. The unique equilibrium is one of two types: separating (in which low-risk consumers select a collateralized loan and high-risk consumers select a credit card loan), or pooling (in which both types of consumers choose credit card loans). I show that a change in the banks' cost of funds can have an ambiguous effect on the credit card rate, so that the credit card rate need not fall when the cost of funds does. Usury ceilings on credit card rates are detrimental to consumer welfare, so would be counter to their legislative intent.I thank George Mailath, Paul Calem, Gerhard Clemenz, Sally Davies, George Kanatas, Leonard Nakamura, Tony Santomero, Tony Saunders, participants in the 1990 Financial Management Association Meetings, and co-editor Michael Woodford for helpful comments.The views expressed here are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.     

Do Federal Reserve communications help predict federal funds target rate decisions?

We explain federal funds target rate decisions using macroeconomic variables and Federal Reserve communication indicators. Econometrically, we employ an ordered probit model of a Taylor rule to predict 75 target rate decisions between 1998 and 2006. We find, first, that our communication indicators significantly explain target rate decisions and improve explanatory power in and out of sample. Second, speeches by members of the Board of Governors and regional presidents have a statistically significant and equal-sized effect, whereas the less-frequent monetary policy reports and congressional hearings are insignificant. Third, our findings are robust to variations in the specification, including changes in the communication strategy. Finally, our communication indicator based on Federal Reserve speeches performs better in explaining target rate decisions than do newswire reports of Fed communications.     

Language after liftoff: Fed communication away from the zero lower bound

This paper examines the Federal Reserve's communication strategy to see how well it has worked and how it can be improved. It argues that Federal Reserve communication when short-term interest rates are no longer constrained by the zero lower bound should be focused on relaying a data-based reaction function which informs market participants how interest rates will adjust as new information arrives. Instead, the Federal Reserve in recent years has relied more heavily than desired on “time-based” forward guidance, focusing on when interest rates are likely to rise rather than under what circumstances. We argue that, except under unusual circumstances, this is an imprudent strategy, as it mutes the effect of macroeconomic news on interest rates and unnecessarily places restrictions on future Federal Reserve action when new information arrives. We argue that the Federal Reserve can improve communication in the current environment by moving away from time-based forward guidance, clarifying how interest rates are likely to change given new information, and providing more information in the Summary of Economic Projections.     

An empirical investigation into the impact of US federal government budget deficits on the real interest rate yield on intermediate-term treasury issues, 1972–2012

This study provides new empirical evidence on the impact of the federal budget deficit on the real interest rate yields on intermediate-term debt issues of the US Treasury, represented herein by the ex post real interest rate yields on 3-year Treasury notes and 7-year Treasury notes, two interest rate measures that have received essentially no attention in the economics and finance literature in recent years. This study is couched within a loanable funds model that includes two ex post real interest rate yields, the monetary base as a per cent of GDP, the change in per capita real GDP, net financial capital inflows as a per cent of GDP and the budget deficit as a per cent of GDP. This study uses annual data for the study period 1972 to 2012, a time period that includes ‘quantitative easing’ monetary policies by the Federal Reserve. Two-stage least squares estimations reveal that the federal budget deficit, expressed as a per cent of GDP, exercised a positive and statistically significant impact on the ex post real interest rate yields on both 3-year and 7-year Treasury notes, even after allowing for quantitative easing and other factors. The study also considers the time period 1980 to 2012 and offers simple robustness testing.     

Cyclical variation in the short-run Federal Reserve reaction function, 1969–1978

This note reports an empirical study of the Federal Reserve reaction function, as indicated by changes in the Federal funds interest rate, for the period from 1969–1978. In particular we examine whether changes in the funds rate have shown responses to underlying economic conditions which vary on a cyclical basis. We find that the Fed reacted more strongly to downturns than to recovery, with its response during the early recovery phase perhaps even procyclical. We also find that response to changes in inflation was less significant than reaction to output fluctuations.     

A general model for short-term interest rates

A general one-factor model for short-term interest rates is proposed. Besides the long memory fractionally integrated mean process, the model also consists of a power function of the interest rate as well as the GARCH effect in the conditional variance. The estimation results show that, while there is no evidence for fractional integration in the mean beyond the well-known martingale property, both the power function of the interest rate and the GARCH effect (but not the ARCH effect) are highly significant in the formation of the conditional variance. Test results also confirm a structure change in October 1979 due to the shift in the Federal Reserve monetary policy.     

Near unit root and the relationship between inflation and interest rates: A reexamination of the Fisher effect

Tests of the Fisher effect are plagued by high persistence in interest rates. Instead of standard regression analysis and asymptotic results, methods relying on local-to-unity asymptotics are employed in testing for the Fisher effect with monthly U.S. data covering the period 1953:1–1990:12. These procedures are extensions of a recently presented method (Cavanagh, Elliott and Stock (1995)) based on simultaneous confidence intervals, and they have the advantage of being asymptotically valid whether interest rates are integrated of order one or zero, or near unit root processes. Taking appropriately account of the near unit root problem the findings in most of the previous literature are reconfirmed. There is support for the Fisher effect in the interest rate targeting period (1953:1–1979:10) of the Federal Reserve but not in the 1979:11–1990:12 period. First version received: July 1999/Final version received: April 2000     

The Policy Anticipation Hypothesis: Evidence from the Federal Funds Futures Market

In an era of increasingly transparent policy making by the Federal Reserve, market participants appear to interpret each economic announcement based on the implication for monetary policy. As a result, when macroeconomic news arrives economic agents revise their expectations of upcoming policy decisions and interest rates move accordingly. This article provides empirical support for this policy anticipation hypothesis utilizing the Federal funds futures market to proxy for policy expectations. The results indicate that once one controls for the role of policy anticipation the impact of many announcements on bond yields becomes statistically insignificant. (JEL E4 , E5 , G1 )     

Interest rate pass through and asymmetric adjustment: evidence from the federal funds rate operating target period

This study examines the long-run interest rate pass through of the federal funds rate to the prime rate and whether there is asymmetric adjustment in the prime rate using the Enders–Siklos (2001) momentum threshold autoregressive model over the period February 1987 to October 2005. Once allowance is made for the endogenously determined structural break in the cointegrating relationship in April 1996, the adjustment of the prime rate to changes in the federal funds rate appears asymmetric with upward rigidity, a result contrary to previous studies which found that the prime rate exhibits downward rigidity. The finding of upward rigidity in the prime rate lends support for the customer reaction and adverse selection hypotheses. Moreover, the empirical evidence seems to support the observation of increased pass through as a result of heightened competition in the banking industry as well as the Federal Reserve's enhanced transparency in monetary policy during the 1990s.     

Interest on reserves,settlement, and the effectiveness of monetary policy

Over the last several years, the Federal Reserve has conducted a series of large scale asset purchases. The effectiveness of these purchases is dependent on the monetary transmission mechanism. Former Federal Reserve chairman Ben Bernanke argued that large scale asset purchases are effective because they induce portfolio reallocations that ultimately lead to changes in economic activity. Despite these claims, a large fraction of the expansion of the monetary base is held as excess reserves by commercial banks. Concurrent with the large scale asset purchases, the Federal Reserve began paying interest on reserves and enacted changes in its Payment System Risk policy. In this paper, I estimate the effect of the payment of interest on reserves (as well as other payment policy changes) on the demand for daylight overdrafts through Fedwire. Since Fedwire provides overdrafts at a fixed price, any fluctuation in the quantity of overdrafts is a change in demand. A reduction in overdrafts corresponds with an increase in the demand for reserves. I show that the payment of interest on reserves has had a negative and statistically significant effect on daylight overdrafts. Furthermore, I interpret these results in light of recent theoretical work. I argue that by paying an interest rate on excess reserves that is higher than comparable short term rates, the Federal Reserve likely hindered the portfolio reallocation channel outlined by Bernanke. Thus, the payment of interest on reserves increased payment processing efficiency, potentially at the expense of limiting the ability of monetary policy to influence economic activity.     

Measuring stress in money markets: A dynamic factor approach

We extract an index of interest rate spreads from various money market segments to assess the level of funding stress in real time. We find that during the 2007–2009 financial crisis, money markets switched between low and high stress regimes except for brief periods of extreme stress. Transitions to lower stress regimes are typically associated with the non-standard policy measures by the Federal Reserve.     

Optimal versus realized policy rules in a regime-switching framework

In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.