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Working Paper 86-2
THE REACTION OF INTEREST RATES TO UNANTICIPATED
FEDERAL RESERVE ACTIONS AND STATEMENTS, 1977-1984:
IMPLICATIONS FOR THE MONEY ANNOUNCEMENT CONTROVERSY
Timothy Cook
and
Thomas Hahn
Federal Reserve Bank of Richmond
June 1986
*The views expressed in this paper are solely those of the authors and do
not necessarily represent those of the Federal Reserve Bank of Richmond or
the Federal Reserve System. The authors are grateful to Marvin Goodfriend
for many useful discussions on this paper. Helpful comments were also
provided by Al Broaddus, Monica Hargraves, Bob King, and Tim Rowe. Any
remaining errors are our responsibility.
THE REACTION OF INTEREST RATES TO UNANTICIPATED FEDERAL RESERVE ACTIONS AND
STATEMENTS, 1977-1984: IMPLICATIONS FOR THE MONEY ANNOUNCEMENT CONTROVERSY*
I. Introduction
Considerable attention has been devoted to the reaction of interest
rates, foreign exchange rates, and stock prices to unanticipated money growth
revealed by the weekly MI money stock announcement.
Numerous articles have
attempted to explain why nominal interest rates rise following the announcement of an MI figure higher than expected and fall when an Ml figure is lower
than expected.
The major controversy in this literature is whether the
observed reaction of interest rates reflects changes in the inflation expectations component or in the real rate component of the nominal rate.
Under the inflation expectations hypothesis a higher than expected MI
figure signals market participants that money growth and inflation will be
higher in the future than previously expected. Consequently, inflation
expectations and the nominal interest rate rise.
Alternatively, under the
policy anticipations hypothesis the monetary authority reacts to deviations of
Ml growth from target by changing the Federal funds rate in order to influence
money demand and return money to path.
Consequently, the announcement of a
higher than expected Ml figure leads market participants to revise upward the
expected path for the funds rate.
Other interest rates rise in reaction to
higher expected values of the funds rate.
Under this hypothesis the observed
*The views expressed in this paper are solely those of the authors
and do not necessarily represent those of the Federal Reserve Bank of
Richmond or the Federal Reserve System. The authors are grateful to Marvin
Goodfriend for many useful discussions on this paper. Helpful comments were
also provided by Al Broaddus, Monica Hargraves, Bob King, and Tim Rowe. Any
remaining errors are our responsibility.
1For empirical studies of the reaction of interest rates to money
announcements, see Hardouvelis [15], Cornell [5] [6] [7], Loeys [16], Roley
[21], Roley and Walsh [23], and Urich [25]. Engel and Frankel [8] and
Cornell [4] evaluate the reaction of exchange rates to money announcements.
Pearce and Roley [19] and Cornell [6] [7] study the reaction of stock prices
to money announcements.
-2rise in nominal interest rates following a higher than expected Ml figure
reflects a rise in the real interest rate.2
Numerous empirical results from the money announcement literature are
inconsistent with the inflation expectations hypothesis. The most widely
cited is the significant appreciation of the dollar in the foreign exchange
market following the announcement of an Ml figure that is higher than expected.3
The evidence that has been put forward as inconsistent with the policy anticipations hypothesis is the strong reactionlafter October 1979 of long-term and
forward interest rates as far as five years in the future to unanticipated
changes in Ml.
Cornell [6] and Hardouvelis [15], among others, reject the
policy anticipations hypothesis as a consistent explanation for all market
i
~~~~~~~4
reactions to money announcements because of this empirical result.
Their
See Roley and Walsh [23], Urich [25], and Nichols, Webster and
Small [18] for models of the policy anticipations hypothesis. See Roley and
Walsh [23] and Engel and Frankel [8] for models of the inflation
expectations theory.
2
According to the model of exchange rate determination in Engel
and Frankel [8], a rise in inflation expectations in response to a higher
than expected Ml number would be associated with a depreciation of the
dollar. For the empirical evidence, see Section IIL of this paper, Engel
and Frankel [8], and Hardouvelis [15]. Additional evidence against the
inflation expectations view includes the sharp jump in the reaction of
interest rates to money announcements following the October 1979
announcement of the change in Federal Reserve operating procedures. Models
of the inflation expectations view cannotlaccount for why the value of Ml
announcements in predicting inflation rose sharply at that time. Further,
Cornell [4], building on work by Fama [9], points out that because inflation
is more closely correlated with growth of the monetary base than with Ml
growth, innovations in the base should also have a significant impact on
interest rates. However, Cornell finds that announced "innovations in the
monetary base had little impact on interest rates." Finally, Frankel and
Hardouvelis [12] find that commodity prices fall following the announcement
of an Ml figure higher than expected. The decline in these prices would not
be expected if inflation expectations rise following Ml announcements.
3
Hardouvelis [15] uses the inflation expectations hypothesis to
(Footnote Continued)
- 3 rejection of the hypothesis is based on the assumptions that (1) long-term
interest rates are determined through an expectations theory of the term
structure and (2) the Fed is unable to influence expected real interest rates
far in the future (i.e. further than one year).
Under these assumptions, an
upward revision in the expected funds rate path following a higher than
expected Ml figure would not be expected to cause large movements in long-term
interest rates or movements in forward interest rates as far as five years in
the future.
If either of these assumptions is incorrect, however, then the
rise in long-term interest rates following a higher than expected Ml figure
may reflect an upward revision in the expected funds rate path.
Our goal in this paper is to evaluate whether the reaction of long-term
and forward interest rates to money announcements in the period after October
1979 is consistent with the policy anticipations hypothesis. We do this by
documenting specific actions and statements of the Federal Reserve from
September 1977 through July 1984 that provided the public with new information
about the future path of the Federal funds rate.
We argue that the actions
and statements that cause an upward revision in the expected funds rate path
do not raise inflation expectations and those that cause a downward revision
in the expected funds rate path do not lower inflation expectations.
On these
grounds, we view the movement in nominal rates following these events as
movements in real rates in response to new information about the future
behavior of the funds rate.
This enables us to evaluate whether the reaction
of long-term and forward rates to announcements of unanticipated changes in Ml
(Footnote Continued)
explain the reaction of forward interest rates to the announcement of
unexpected money growth. Cornell [5,6] proposes the inflation expectations
theory as a possible explanation of the reaction of spot interest rates.
Both authors view the significant reaction of long-term and long-forward
interest rates as evidence against the policy anticipations view.
-4
-
is consistent with the policy anticipations hypothesis by comparing the
reaction of rates to these announcements with the reaction of rates to the
policy events we document.
Specifically, if policy anticipations underlie the reaction of rates to
money announcements we should find that (1) the relative reaction of longversus short-term rates to the policy events we document is similar to the
relative reaction of these rates to unanticipated changes in Ml (i.e. we
should see relatively large movements in long-term rates after October 1979),
and (2) the reaction of forward rates to these policy events is similar to the
reaction of forward rates to unanticipated changes in MI. The behavior of
interest rates on days of policy events we document in this paper exhibits
both these characteristics. Consequently! we conclude that the reaction of
both short- and long-term interest rates to money announcements is consistent
with the policy anticipations view that the reaction reflects changes in the
real rate component of the nominal rate caused by revisions in the expected
funds rate.
II. Procedures
We use the daily "Credit Market" column in the Wall Street Journal to
identify Federal Reserve actions and statements that changed expectations of
the future path of the Federal funds rate.:
The shorthand term we use for
these events is "policy surprise." The three classes of events we look at are
open market operations, discount rate announcements, and Federal Reserve
policy statements. The latter category includes semiannual policy reviews,
the release of Federal Open Market Committee directives, and special announcements about policy.
We designated a Federal Reserve action or statement a
surprise if (1) the action or statement was the headline story and major theme
of the "Credit Market" column in the Journal and (2) if the Journal reported
as a factual matter that the action or statement caused a reaction in market
rates.
We used these criteria so that we could follow a specific rule in
- 5choosing surprises that could be verified by others and so that we would
include only the most clear cut cases in which a monetary policy event was the
major factor affecting rates in a given day.
As an example consider the open market operation of September 8, 1980.
Prior to the Fed's daily open market operation, market participants believed
that the effective trading range for the Federal funds rate--the range over
which the funds rate could vary without causing intervention by the Fed--was 9
1/2 to 10 1/2%, and had expectations of what the Fed was going to do in the
market in order to maintain this range.
Contrary to these expectations, with
the funds rate at 10 1/4% the Desk did an open market operation to drain
reserves.
This action caused an upward revision in the market's perception of
the Federal funds rate range desired by the Fed.
The Treasury bill rate,
which depends on current and expected levels of the funds rate over the
maturity of the bill, rose sharply following the operation.
The following day
the headline and major theme in the Journal's "Credit Market" column was the
unexpected Federal Reserve action and the reaction of interest rates to it.
This is one of the events we use in this study.
A critical assumption of this approach is that the Journal has the
incentive and the technology to accurately report monetary policy actions and
statements that are surprises to the market.
entirely reasonable.
We believe this assumption is
There are thousands of Fed-watchers, financial analysts
and traders watching their Telerate monitors each day when the Fed does an
open market operation or makes an important announcement. A major unexpected
Federal Reserve action or statement is common knowledge throughout the financial markets.
The Journal's incentive to accurately report these events and
the reaction of interest rates to them is no less than its incentive to
accurately report other events.
-6
-I
After identifying Federal Reserve actions and statements that caused a
revision in the expected future path of the funds rate, we look at the movement in short-term, long-term and forward rates immediately following these
events.
The change in rates is calculated using daily 3:30 p.m. data
surrounding the event.
We stress that we are not using this procedure to
identify the magnitude of policy surprises or the magnitude of the reaction of
short-term rates to policy surprises; rather we are using it to identify the
relative movement in long-term versus short-term interest rates on policy
surprise days.
We view the observed response of nominal rates to policy surprises as
real interest rate movements.
Implicitly, we have made the assumption that a
policy surprise which causes an upward revision in the expected funds rate
path does not raise inflation expectations and that a surprise which indicates
a lower funds rate path does not lower inflation expectations. There are two
possible objections to this inflation expectations assumption.
First, one
could argue that the Fed changes the funds rate path because it receives
inflation-related data, not yet released to the public, that indicates that
inflation will be higher or lower than previously expected.
The policy
surprise in this scenario reveals to the public the Fed's inside information
on this data.
In particular, this inside information might include data
compiled by the Fed, such as money supply land industrial production figures.
We have examined the possibility thatipolicy surprises provide the public
with new information about unreleased data, compiled by the Fed.
First, we
tested whether policy surprises influenced the market's expectation of the
upcoming Ml release by evaluating whether the market's reaction to unexpected
Ml growth differed if a policy surprise occurred shortly before the release.
- 7 -
We found no support for this hypothesis.5 Second, evidence presented in Roley
and Troll [22] shows that the unanticipated component of industrial production
release did not have a significant announcement effect on short-term interest
6
rates in the post October 1979 period.
It is reasonable to assume that if
the unexpected component of the industrial production announcement had no
effect on interest rates, then the movement of rates on policy surprise days
was not caused by the public inferring movement in this variable compiled by
the Fed.
Potentially there are other inflation related variables not collected by
the Fed that it may have access to before the public and some of these variables may be relevant for the determination of interest rates.
Roley and
Troll also investigated the announcement effects on short-term interest rates
of the unanticipated component of the monthly consumer price index (CPI), the
producer price index (PPI), and the unemployment rate.
were significant in the post-October 1979 period.
None of these variables
Using a different interest
5 The test was conducted by using a dummy variable in the money
announcement regressions reported in Section III that takes a non-zero value
on money announcement days when a policy event occurred between the MI
survey day (usually Tuesday) and the money announcement (usually late
Friday). The dummy variable is +1 when the policy event indicates a higher
funds rate path and -1 when the event indicated a lower funds rate path.
The motivation for the test is to determine whether policy surprises alter
market participants' estimates of that weeks's announced Ml figure. If Ml
estimates are significantly revised, then the expected sign for the dummy
variable coefficient is negative since a Fed tightening would raise the
expected Ml figure relative to the available survey number and lower the
actual response of interest rates relative to the predicted response. In
all regressions for the interest rates and exchanges rates, the coefficient
of the dummy variable was not significant with the predicted sign. These
regressions are reported in Appendix B.
6 Roley and Troll [22] employ a three-month Treasury bill interest
rate series. All expectation figures are median figures from surveys
conducted by Money Market Services. For the period October 1979 to October
1982, the t-statistic for the unanticipated component of the announcement of
the industrial production index is less than 1.
-
8 -I
rate, Urich and Wachtel [261 find that the announcement of the unanticipated
component of the PPI did have a significant effect on short-term interest
7
However, the magnitude
rates over the period from October 1979 to July 1982.
of the response to the unexpected component of the PPI announcement is small
relative to the movement in interest rates in response to the policy surprises
we have identified. Urich and Wachtel report that the standard deviation of
the unexpected component of the monthly PPI over this period was 3.6 percent.
According to their estimates, an unexpected increase in the PPI of this
magnitude caused an 11 basis point movement in short-term rates.
The average
absolute movement in the six-month bill rate in this period on days of the
policy surprises we have catalogued is 41 basis points.
In view of the large
difference between these numbers it is highly implausible that the reaction of
rates to policy surprises reflects revisions in expectations of the PPI.
The second argument against our assumption that a policy surprise which
causes an upward revision in the expected funds rate path does not raise
inflation expectations relies on the viewithat the Fed has a superior model of
inflation than the public.
Under this hypothesis, a policy surprise indicat-
ing a higher funds rate target path indicates to the public that the Fed's
outlook for inflation has deteriorated.
This, in turn, leads to an increase
in inflation expectations. However, there is no reason to believe that the
Fed has a superior forecasting model of inflation, and we know of no evidence
that it does.
Additional evidence against the view that interest rates react to policy
surprises because of changes in inflation expectations is the behavior of the
Urich and Wachtel [26] use rates for International Money Market
futures contracts on three-month Treasury 'bills and survey data on expected
PPI figures collected by Money Market Services.
7
- 9 -
dollar exchange rate.
As will be shown below, the dollar generally appreci-
ated (depreciated) following policy surprises indicating a higher (lower)
funds rate path.
If policy surprises were moving nominal interest rates
because of their effect on inflation expectations, the dollar would have
behaved in the opposite fashion.
The remainder of this paper examines the reaction of market rates to
monetary policy surprises and money announcements in three periods.
The first
period goes from September 1977 to October 6, 1979 when the Fed announced the
change to a nonborrowed reserves operating procedure.
The second goes from
October 6, 1979 through October 9, 1982 when the Fed formally announced the
deemphasis of MI targeting.
This announcement is generally regarded as
marking the end of the post-October 1979 operating procedures.
period goes from October 9, 1982 through July 1984.
The third
These three periods are
called period 1, period 2, and period 3 in the remainder of the paper.
Our
discussion starts with and emphasizes the period from October 1979 to October
1982 because this is the period focused on in the money announcement
controversy.
III. Period 2 Policy Surprise Data
Period 2 starts with the October 6, 1979 Federal Reserve announcement of
the change to operating procedures designed to pay more attention to the
quantity of bank reserves in order to gain firmer control over the money
stock, and ends with the October 9, 1982 Federal Reserve announcement of the
deemphasis of Ml.
There has been a substantial amount of debate over the
actual nature of the operating procedures used by the Fed during this period.
The debate is over whether the Fed followed a strict nonborrowed reserves rule
in which movements in the funds rate were in some sense "endogenously"
-
10
determined or whether the Fed, as in the pre-October 1979 period, continued to
control movements in the funds rate through adjustments in the nonborrowed
reserves target and through changes in the discount rate.
Whatever the
appropriate description of Fed procedures in this period, as Poole [20] has
emphasized, market participants remained intensely interested in day-to-day
actions and statements of the Fed, and viewed these actions and statements as
providing information about the future path of the funds rate.
Because it is
the impact of these day-to-day actions and statements on market rates that we
are interested in this paper, we do not discuss Federal Reserve or other
descriptions of the operating procedures in any detail here.
Open Market Operations As in the pre' October 1979 period, open market
operations in the post-October 1979 period were viewed by market participants
as providing information about the future path of the funds rate.
The differ-
ence from the pre-October 1979 period was that the Fed's effective range for
the funds rate--the range over which the funds rate could vary without causing
intervention by the Fed--was viewed by market participants as being considerably larger and subject to more uncertainty after October 1979.
However,
market participants still closely scrutinized daily open market operations to
pick up movements in this trading range and reacted strongly to these movements.
The criteria described above for choosing policy surprises yielded 27
open market operation surprises in this period.
For each of these surprises
Table Al shows the Journal headline and a quote describing the development
that changed market expectations of the future path of the funds rate.
Many
of these surprises occurred either when the funds rate moved out of its
perceived trading range and the Fed took no action, or when the Fed took an
unexpected action when the funds rate was within its perceived trading range.
-
11
-
Table 1 shows the movement of spot interest rates, forward rates and the
dollar/mark exchange rate on all the policy surprises days in period 2.8
The average increase in bill rates on days of surprise open market
operations indicating a higher funds rate path was 19 basis points, while the
average decrease on days indicating a lower funds rate path was 38 basis
points.
The corresponding averages for the 20-year maturity were 11 and 15
basis points, respectively.
With only three exceptions, bond rates moved in
the same direction as the expected funds rate path on days of open market
operation surprises.
The 3-year ahead 2-year forward rate moved in the same
direction as the open market operation surprise in 20 out of 27 cases.
The
average increase was 7 basis points when surprises indicated a higher funds
rate path and -9 basis points when surprises indicated a lower funds rate
path.
The 5-year ahead 2-year forward rate showed no tendency to move
systematically with open market operation surprises.
Federal Reserve Policy Announcements
The criteria for policy surprises
yielded five announcements that were surprises in the October 1979 to October
1982 period.
These included three special policy announcements, one release
of an FOMC directive, and one semiannual policy review before Congress. Table
A2 shows the Journal headline and a quotation describing each announcement and
8 Appendix C contains a description of the data used in this paper.
In calculating the forward rates from coupon bonds, we use the duration
weighted approach presented in Shiller, Campbell and Schoenholtz [24]. In
Appendix A, we show that the day-to-day change in the forward rates calculated
by this method are extremely sensitive to errors in the spot data used in
the calculations. Since the constant maturity series is constructed from a
daily yield curve drawn by the Treasury, it is possible that small errors in
this data are not uncommon. When calculating changes in forward rates from
spot rates with long maturities, small errors in the spot data can yield
errors 15 times as large (for the 20-year ahead 10-year forward rate) in the
forward rate data. For this reason, we have not presented any forward rates
further than 5 years ahead.
TABLE 1
The Movement in Interest Rates and the Exchange Rate
on Policy Surprise Days in Period 2
OPEN
MARKET
OPERATIONS
DAY
DATE
11-Feb-80 Mon
29-Apr-80 Tue
02-May-80 Fri
06-May-80 Tue
08-May-80 Thu
10-Jun-80 Tue
11-Jun-80 Wed
31-Jul-80 Thu
02-Sep-80 Tue
03-Sep-80 Wed
08-Sep-80 Mon
15-Oct-80 Wed
25-Nov-80 Tue
07-Jan-81 Wed
02-Apr-81 Thu
23-Jun-81 Tue
13-Jan-82 Wed
19-Jan-82 Tue
21-Jan-82 Thu
22-Mar-82 Mon
08-Jul-82 Thu
09-Aug-82 Mon
12-Aug-82 Thu
13-Sep-82 Mon
15-Sep-82 Wed
16-Sep-82 Thu
29-Sep-82 Wed
DAY
DATE
DISCOUNT RATE 06-Oct-79 Sat
ANNOUNCEMENTS 15-Feb-80 Fri
25-Sep-80 Thu
14-Nov-80 Fri
04-Dec-80 Thu
04-May-81 Mon
19-Jul-82 Mon
30-Jul -82 Fri
13-Aug-82 Fri
1/
2/
DAY
DATE
06-Oct-79 Sat
POL ICY
ANNOUNCEMENTS 07-Oct-82 Thu
09-Oct-82 Sat
03-Apr-81 Fri
10-Feb-82 Wed
0.10
0.10
0.04
0.16
0.02
-0.15
-0.15
-0.36
-0.14
-0.24
-0.04
0.18
-0.04
-0.02
0.11
-0.20
-0.01
0.15
0.01
-0.13
-0.14
-0.34
-0.15
-0.14
-0.08
0.01
-0.01
-0.04
0.07
-0.17
0.24
-0.24
-0.64
0.11
-0.11
-0.07
-0.07
6Month 3Year
1.07
0.55
0.67
0.37
0.51
0.17
0.88
0.37
0.46
0.16
0.64
0.55
-0.28 -0.23
-0.70 -0.31
-0.47 -0.34
0.32
0.63
-0.48 -0.29
0.36
0.68
5Year
0.55
0.33
0.13
0.25
0.02
0.51
-0.15
-0.27
-0.24
0.25
-0.22
0.31
7Year 20Year 3OYear F(3,2) F(5,2)
0.12
0.55
0.29
0.25
0.46
0.04
0.25
0.27
0.27
0.21
0.05 -0.01
0.15
0.15
0.10
0.44
0.01
0.16
0.15
0.29
-0.08 -0.10 -0.26 -0.07
0.D0
0.46 -0.06
0.19
0.13
0.40
0.01 -0.20
-0.16 -0.10 -0.10
-0.25 -0.26 -0.25 -0.19 -0.18
0.10
-0.17 -0.17 -0.18 -0.04
0.07
0.10
0.14
0.21
0.11
-0.19 -0.18 -0.18 -0.07 -0.09
0.10
0.19
0.19
0.27
0.16
DM
-1.46
-0.07
-0.34
-0.96
-0.53
-0.90
1.01
1.45
-0.35
-0.56
0.70
-0.57
6Month 3Year
1.07
0.55
-0.59 -0.71
-0.57 -0.43
0.48
1.22
-0.13 -0.11
0.52
1.15
-0.43 -0.4?
5Year
0.55
-0.71
-0.31
0.39
-0.13
0.47
-0.38
7Year 2OYear 3OYear F(3,2) F(5,2)
0.12
0.25
0.29
0.55
0.46
-0.63 -0.46 -0.40 -0.71 -0.32
-0.27 -0.37 -0.34 -0.06 -0.12
0.21
0.34
0.58
0.43
0.31
-0.13 -0.11 -0.16 -0.17 -0.13
0.35
0.30
0.30
0.38
0.45
-0.34 -0.31 -0.30 -0.31 -0.19
DM
-1.46
1.92
0.53
-1.43
0.21
-1.45
0.89
6Month
0.30
-0.42
-0.82
-0.50
-0.11
0.11
-0.30
0.31
-0.27
-0.22
0.31
-0.21
-0.13
0.87
0.25
0.13
0.31
0.14
0.13
-0.37
-0.64
-0.27
-0.52
-0.19
0.24
-0.15
-0.16
0.19
-0.38
END DATE
09-Oct-79
15-Feb-80
26-Sep-80
17-Nov-80
05-Dec-80
05-May-81
20-Jul-82
02-Aug-82
16-Aug-82
-OR+
+
+
+
+
+
+
-
MEAN +
MEAN MEAN +
END DATE -OR+
09-Oct-79
07-Oct-82
12-Oct-82
06-Apr-81
10-Feb-82
MEAN +
MEAN -
-
FORWARD RATES
SPOT RATES
5Year 7Year 2OYear 3OYear F(3,2) F(5,2)
0.01
0.03
0.24
0.22
0.15
0.12
0.24
0.10
0.03
0.04
0.02
0.00
-0.55 -0.48 -0.29 -0.25 -0.47 -0.21
0.26
-0.37 -0.24 -0.23 -0.12 -0.12
0.06 -0.41
0.15
0.18
0.01
0.12
0.15
0.08
0.13
0.14
0.11
0.10
-0.10 -0.11 -0.09 -0.09 -0.14 -0.15
0.13
0.05
0.29
0.21
0.28
0.25
0.08 -0.25
-0.21 -0.22 -0.19 -0.19
-0.32 -0.29 -0.18 -0.14 -0.24 -0.18
DM *
0.03
-0.13
-1.10
0.07
-0.64
-0.09
-0.11
-0.34
0.39
0.32
0.37
-0.05
0.02
-0.72
-1.28
-0.80
-1.07
-0.41
0.00
-0.86
0.13
0.35
0.96
0.03
-0.18
0.66
-0.20
-0.38
0.05
END DATE * -OR+
+
11-Feb-80
29-Apr-80
02-May-80
06-May-80
+
08-May-80
+
10-Jun-80
11-Jun-80
+
31-Jul-80
02-Sep-80
03-Sep-80
+
08-Sep-80
15-Oct-80
+
25-Nov-80
+
07-Jan-81
+
02-Apr-81
+
23-Jun-81
+
13-Jan-82
+
19-Jan-82
+
21-Jan-82
22-Mar-82
08-Jul-82
09-Aug-82
12-Aug-82
13-Sep-82
+
15-Sep-82
16-Sep-82
+
29-Sep-82
MEAN +
MEAN -
3Year
0.21
-0.12
-0.59
-0.49
0.15
0.11
-0.08
0.39
-0.35
-0.36
0.16
-0.09
0.06
0.47
0.15
0.04
0.18
-0.07
-0.15
-0.16
-0.44
-0.16
-0.24
-0.11
0.23
-0.07
-0.07
0.13
-0.25
0.11
0.09
0.11
0.09
0.01
0.01
-0.06
0.07
0.40
-0.05
0.03
0.33
-0.05
-0.02
0.20
0.12
-0.05
-0.01
0.22
0.00
0.09
0.26
-0.01
-0.12
0.06
0.15
0.00
0.10
0.09
0.13
0.20
0.09
-0.11
-0.19
-0.20
0.04
0.12
0.20
-0.15
-0.13
-0.20
-0.20
0.11
-0.03
-0.06
-0.11
-0.26
-0.10
-0.10
-0.19
-0.11
-0.15
0.01
-0.07
0.03
0.11
-0.13
-0.24
0.10
0.08
0.02
0.08
0.07
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0.14
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0.00
0.00
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1/ EXCLUDES 10/6/79
2/ EXCLUDES 10/6/79 AND 12/4/80
"End Date" is the day to which the change in
*'Date" is the calendar day of the event.
rates (as of 3:30 p.m.) is calculated. "DM" is the percentage change in the dollar per
German mark exchange rate.
- 12 -
the effect it had on anticipations of Fed policy.
The rate movements on these
days are shown on Table 1.
The first special policy announcement was the October 6, 1979 announcement of the change in Federal Reserve operating procedures. The change in
procedures was part of an anti-inflationary package that also included a one
percent increase in the discount rate and the establishment of an 8% reserve
requirement for certain liabilities of the Fed's member banks and various
other institutions.
In announcing the program Chairman Voleker said that the
growth of money and credit had been "in excess of the amounts we'd like to
see"l and that the new operating procedures would bring the money supply "under
surer control."
(October 8, 1979 Journal, p. 1)
Numerous stories in the
Journal following the announcement reported the widespread view that it
signaled a higher funds rate path.
Following the announcement, the six-month
bill rate increased 107 basis points, the five-year Treasury rate rose 55
basis points,
and the twenty-year rate increased 29 basis points.
The three-
and five-year forward rates rose 55 and 12 basis points, respectively. The
dollar rose 1.46 percentage points against the mark.
The next special policy announcement was the announcement by Chairman
Volcker on Saturday October 9, 1982 of the deemphasis of Ml.
This announce-
ment was widely viewed as formally signaling the end of the October 6, 1979
operating procedures. The announcement came at a time when Ml had been
growing at a rate well above the annual target range, and was correctly
interpreted as indicating that the Fed would not raise the funds rate in order
to bring Ml back into the range.
For this reason it caused a downward re-
vision in the expected funds rate Path and an upward revision in the expected
growth rate of Ml.
The announcement was leaked by the Journal on the preced-
ing Thursday and there was a very strong market reaction to both the leak and
the announcement. Consequently, we treat these as two separate events in
-
Table 1.
13 -
On the days of the leak and the announcement the six-month bill rate
fell a total of 116 basis points.
Intermadiate-term rates fell only slightly
less, while the twenty and thirty-year bond rates fell 83 and 74 basis points.
The three- and five-year forward rates fell 77 and 44 basis points.
The
dollar fell 2.45 percentage points against the mark.
The surprise directive release occurred on April 3, 1981 when the Fed
released the summary of two February 1981 FOMC meetings.
The directive showed
that the FOMC had voted to maintain a Federal funds rate range of 15 to 20%,
when market participants thought that the lower end of the range was well
In reaction to this information the bill rate increased 122 basis
below 15%.
points, intermediate-term rates rose 40 to 50 basis points and long-term rates
rose 30 to 35 basis points.
The three- and five-year forward rates rose 21
and 58 basis points respectively. The dolilar rose 1.43% against the mark.9
The policy review surprise occurred on February 10, 1982.
At that time
the level of Ml was well above the upper bound of its annual target range.
In
his testimony before Congress the Chairman indicated that the Fed would not
raise the funds rate in reaction to this situation. As shown in Table 1, in
response to this assurance, short-term, long-term, and forward interest rates
fell, and the dollar depreciated.
Discount Rate Announcements Discount rate announcements can be classified into three types:
(1) alignment announcements, which indicate the
discount rate is being changed to realign it with market rates, (2) policy
This is a particularly interesting episode because it is totally
immune from the view that the reaction of interest rates to policy surprises
occurs because the public infers inside inflation-related information. In
this case any inside information the Fed had at the time of the FOMC meeting
was released well before the release of the directive.
9
- 14 announcements, which indicate the discount rate is being changed because of
the Fed's concern over the behavior of the money stock, inflation, or other
macroeconomic variables, and (3) hybrid announcements, which contain the
language of both alignment and policy announcements. Treasury bill rates
moved sharply on the 9 days of discount rate changes accompanied by policy or
hybrid announcements in the October 1979 to October 1982 period, and in each
case the Journal reported that the movement in rates followed and was caused
by the discount rate change.
In contrast, rate movements following the six
discount rate changes accompanied by alignment announcements were highly
variable and in the opposite direction in half the cases.
Consequently, in
order to get a group of discount rate changes that unambiguously affected
expectations of the future funds rate path we use only those accompanied
by policy and hybrid announcements. Table A3 provides a record of the nine
policy and hybrid discount rate announcements in period 2 and the change in
rates on the day of these announcements.
Table 1 shows the changes in spot and forward interest rates and the
dollar/mark exchange rate on days of policy and hybrid discount rate announce-
There was a semi-annual policy review on the day following the
hybrid discount rate announcement on late July 19, 1982. The Journal's
comments are somewhat ambiguous in that it attributes the movement in rates
to the Fed's "credit-easing" moves. In examining Treasury bill futures rate
data, however, we found that the movement in rates occurred between the
"settle" preceding the late afternoon discount rate announcement and the
"open" early the following morning. Hence, the daily rate movement can be
safely attributed to the discount rate announcement and not the policy
review.
In another paper [2] we offer an explanation for this phenomenon.
We studied the Federal Reserve's behavior following different types of
discount rate announcements and found that the Fed has systematically used
policy and hybrid announcements to signal a forthcoming change in the
Federal funds rate. Market participants are aware of this practice and have
revised their expectations of the Federal funds rate target path following
these types of announcements.
1 1
- 15
ments.
One of these announcements occurred on the same day as the October 6,
1979 policy announcement, so we exclude it from the following discussion. The
average increase in the bill rate on days of the other discount rate increases
accompanied by policy or hybrid announcements was 63 basis points, while the
average decrease on days of discount rate cuts accompanied by policy or hybrid
announcements was 48 basis points.
In seven out of eight cases the twenty-
and thirty-year bond rates moved in the same direction as the bill rate.1
In
these seven cases the average movement in Ithe twenty-year bond rate was 19
basis points.
The three-year forward rate moved in the same direction as the
discount rate in five cases, in the opposite direction in one case, and was
virtually unchanged in two cases.
In all but one instance the dollar appreci-
ated (depreciated) against the mark following an increase (decrease) in the
discount rate.
In summary, in almost every instance in period 2 long-term rates moved in
the same direction as the change in the funds rate path implied by the policy
surprises catalogued in this paper and in most cases the movement was substantial.
The three-year forward rate moved in the same direction as the policy
surprise in 29 cases, in the opposite direction in 5 cases, and was virtually
In the one case--December 4, 1980--when daily long-term rates
moved in the opposite direction from the discount rate there is evidence
that this movement was due to some development other than the discount rate
change. Data on 20-year Treasury bond future rates from the Chicago Board
of Trade are available from the "settle" at the end of one market day--but
before the late afternoon discount rate announcements--to the "open" early
the following morning, which is a shorter interval than the daily interest
rate data used in our paper. The only announcement that was followed by a
change in the settle-to-open futures rate in the opposite direction from the
change in the daily 20-year spot rate was the December 4, 1980 announcement,
when the futures rate rose 7 basis points while the spot rate fell 8 basis
points. This indicates that the atypical movement in daily spot long-term
rates following this discount rate increase was due to other developments on
the day following the announcement. (We report the behavior of Treasury
bond future rates following discount rate changes in [2b.)
- 16 -
unchanged (i.e., a 0 or 1 basis point change) in 6 cases.
These data
indicate that long-term and forward interest rates well in the future reacted
to policy surprises in the October 1979 to October 1982 period.
We compare
the reaction of rates to policy surprises and to announcements of unanticipated changes in MI below.
Comparison of Rate Movements Following Money Announcements and Policy
Surprises
This section describes two sets of regressions used to compare the
relative response of short- and long-term interest rates to announcements of
unanticipated changes in Ml with the relative response of rates to the policy
surprises we have catalogued.
The first set of regressions are the standard regressions used in the
money announcement literature augmented with three dummy variables that
measure the response of daily interest rates to the policy surprises discussed
above:
1. ARt
= a + b*UMt + c*OMOt +d*DISt + e*ANNt + Ut
The dependent variable, ARt, is the change in the interest rate (in basis
points) for a Treasury security of a given maturity or the change in the
dollar/mark exchange rate (in percentage points) on days of money announcements and policy surprises. The independent variables are UMt, the unexpected
component of the money stock release measured as a percentage forecast error;
OMOt, a dummy variable for the open market operations; DISt, a dummy variable
for the discount rate announcements; and ANNt, a dummy variable for policy
announcements.
13The dollar depreciated (appreciated) against the mark following
policy surprises indicating a higher (lower) funds rate path in 9 out of 40
cases, and in 4 of these cases the change was very small (.13 of a
percentage point or less). As noted earlier, this is evidence that the
(Footnote Continued)
- 17
-
Consider first the coefficients for the money announcement variable.
These are shown in the second column of Table 2.
The coefficients are signif-
icant at the 5% level in all the interest rate and exchange rate regressions.
The results show that the two-year rate three and five years forward are
responding to the announcement of unanticipated Ml growth.
Additionally, the
magnitude of the coefficient in the 30-year bond rate regression is large
relative to the coefficient in the 6-month' bill rate regression: the ratio of
the two coefficients is .31.
Finally, the coefficient in the dollar/mark
exchange rate regression is negative and s ignificant at the 5% level.
Accord-
ing to the model of exchange rate determination described in Engel and Frankel
[81, the significant appreciation of the dollar following announcements of
unanticipated increases in the money stock is support for the policy anticipations hypothesis.14
The three dummy variables in the regressions are intended to measure the
response of daily interest rates to the unexpected open market operations,
discount rate announcements, and other policy announcements we have catalogued.
Each dummy variable is equal to +3 on days when a policy surprise in
that category indicates a higher funds rate path, -1 on days when the surprise
indicates a lower funds rate path, and zero otherwise. The dependent variable
on days when any of the three variables is nonzero is the change in interest
rates or the percentage change in the exchange rate surrounding the event.
(Footnote Continued)
interest rate movements following policy surprises catalogued in this paper
were not due to the public inferring inflation-related inside information
from the Fed.
The results for the money announcement variable are similar to
the results in Gavin and Karamouzis 113) anpd Roley and Walsh [23).
14
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- 18 As shown in the third, fourth, and fifth columns in Table 2, the coefficients of the dummy variables are significant at the 5% level in all spot
interest rate regressions.
While our criteria for choosing policy surprises
assured that the response of short term interest rates to these surprises
would be significant, the significant response of the longer term interest
rates and the magnitude of the coefficients in the longer term rate regressions relative to the coefficients in the bill rate regression would not
necessarily be expected.
In fact, as noted earlier, the key assumption in
much of the money announcement literature is that this response of long-term
rates to policy surprises is not possible.
The ratio of the coefficient of
the open market operation dummy variable in the 30-year bond rate equation to
the coefficient in the bill rate regression is .42.
the discount rate and
tively.
The similar ratios for
policy announcement variables are .20 and .47, respec-
These ratios bracket the comparable ratio for the money announcement
variable.
Additionally, the coefficients of the open market operation and
policy announcement dummy variables are significant at the 5% level in the
3-year ahead 2-year forward rate regression.
In order to compare the relative response of short- and long-term interest rates to money announcements and to policy surprises, the coefficients of
the money announcement variable and the three policy surprise dummy variables
in each spot interest rate regression were divided by the comparable coefficient in the six-month rate regression. The four coefficient ratios for each
maturity are shown in Chart 1.
Overall, the strong response of the longer
term rates relative to the bill rate following money announcements is similar
to the response of long-term rates relative to the bill rate following the
three types of policy surprises.
The first set of regressions have the advantage that they conform to the
money announcement regressions, enabling a direct comparison of the relative
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19 -
magnitude of coefficients at different maturities. They have the disadvantages that they fragment the policy surprise data and that they treat all
surprises within a category as the same.
As a check of the results from these
regressions we report a second set of regressions that summarize the relationship between changes in long-term and forward interest rates and changes in
the bill rate on days of policy surprises.
2.
AR
= a + b* ARTB
These regressions are of the form:
+ et,
where ARt is the change in the long-term rate, forward rate, or exchange rate
on days of policy surprises and ARTBt is the change in the six-month Treasury
bill rate. 1 5
The results are shown in Table 3.
The coefficients in the spot rate
regressions gradually fall to .28 at the 30-year maturity.
Additionally, the
coefficient in the three year ahead forward rate regression implies that a one
percentage point movement in the bill rate on policy surprise days was accompanied by about a one-third of a percentage point change in the forward rate.
The coefficients for the spot rate regressions are plotted in Chart 1.
The pattern of the coefficients for different maturities is very similar to
the pattern of the coefficients for the money announcement variable from the
first set of regressions.
In summary, the evidence from these two sets of regressions indicates
that in the period from October 1979 to October 1982 the reaction of long-term
and forward interest rates to money announcements was similar to the reaction
of these rates to policy events that caused changes in the expected funds rate
The regressions exclude nine policy surprise days on which there
was a money surprise greater than 0.1 percent. These days are February 11,
1980, September 2, 1980, September 8, 1980, November 25, 1980, April 6,
1981, March 22, 1982, August 9, 1982, September 13, 1982, and October 12,
1982. The results are not significantly different when these observations
are included.
15
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- 20 -
path.
Hence, these results are consistent with the policy anticipations view
that both short- and long-term interest rates react to money announcements
because these announcements alter expectations of the future path of the
Federal funds rate.
IV.
Period 1 Policy Surprise Data
In the period from September 1977 to October 6, 1979, the operating
procedure of the Fed is accurately characterized as Federal funds rate targeting.
Under this procedure, the FOMC gave the desk an initial target for the
Federal funds rate.
During the inter-meeting period this target was adjusted
(within the 1/2 to 1 percentage point range specified by the FOMC) in response
to incoming data on money growth and other macroeconomic variables.
By
changing nonborrowed reserves through open market operations, the funds rate
was maintained within a very narrow band (about 1/8 to 1/4 of a percentage
point) around the current objective.
Changes in the Federal Funds Rate Objective
In this period the funds
rate was maintained within such a narrow band around the funds rate objective
that the public was able to accurately perceive changes in the objective.
Perceived target changes were consistently reported on the following business
day in either the money market column or a separate article in the Wall Street
Journal.
We have used the Journal to compile a record of perceived changes
in the target over the September 1977 to October 1979 period.
The 30 reported
target changes are shown in Table A4, along with headlines and quotations
16 Many of the perceived changes in the objectives can be confirmed
changes by consulting the monetary policy and open market
policy
as actual
published in the Federal Reserve Bank of New York
summaries
operation
to 1980.
1978
Reviews,
Quarterly
- 21
-
from the relevant Journal article reporting these changes.
Also shown are the
changes in spot interest rates, forward rates, and the exchange rate.
The
table shows that all reported funds rate changes were positive and that the
most frequent adjustment was 1/8 of a percentage point.
The target rose from
6 1/4% to 11 1/2% over the 24-month period.1 7
Note that in almost all cases the Journal reported the action which
indicated that the target had changed.
Usually, the Desk either allowed the
funds rate to rise to the new objective before adding reserves, or drained
reserves when the funds rate was at or slightly above the old objective.
These actions clearly signaled changes in the objective.
The reaction of spot rates, forward rates, and the exchange rate to
changes in the funds rate objective are shown in a more compact form in the
top panel of Table 4.
On days of increases in the funds rate objective the
six-month bill rate rose in 25 instances, fell in 3 cases, and was unchanged
in 2 cases.
The bill rate frequently roselsharply on days that the objective
was raised:
on 7 days the bill rate rose by more than 20 basis points and on
11 days it increased by more than 10 basis points.
The 30-year rate also rose
following most of the objective changes, but the response was generally weak.
The last row in the top panel shows the mean responses of rates to all funds
rate objective changes excluding days on which a discount rate or money
All but one objective change for this period were reported by
the Journal. We were unable to find a report of the 6 5/8 percent to 6 1/2
percent target change which occurred between October 31, 1977 and January 9,
1978. In eight cases, there was uncertainty about the magnitude of the
target change on the day of the change. In three of those eight cases, the
Journal reported a range which was believed to encompass the new objective.
The midpoint of that range in all three cases was later confirmed as the new
objective. In five of the eight cases, nolrange was reported. However, the
new objective was identified in articles within a few days.
7
TABLE 4
The Movement in Interest Rates and the Exchange Rate
on Policy Surprise Days in Period 1
PERIOD 1
FUNDS
RATE
OBJECTIVE
DATE * DAY
30-Sep-7 7 Fri
07-Oct-77 Fri
31-Oct-77 Mon
09-Jan-78 Tue
19-Apr-78 Wed
27-Apr-78 Thu
18-May-78 Thu
21-Jun-78 Wed
20-Jul-78 Thu
16-Aug-78 Wed
18-Aug-78 Fri
28-Aug-78 Mon
08-Sep-78 Fri
20-Sep-78 Wed
25-Sep-78 Mon
28-Sep-78 Thu
18-Oct-78 Wed
20-Oct-78 Fri
26-Oct-78 Thu
31-Oct-78 Tue
01-Nov-78 Wed
28-Nov-78 Tue
19-Dec-78 Tue
15-Jan-79 Mon
27-Apr-79 Fri
20-Jul-79 Fri
15-Aug-79 Wed
24-Aug-79 Fri
04-Sep-79 Tue
19-Sep-79 Wed
DATE
DISCOUNT RATE
ANNOUNCEMENT 06-Jan-78
18-Aug-78
22-Sep-78
13-Oct-78
01-Nov-78
20-Jul-79
16-Aug-79
SPOT RATES
SYear 7Year
END DATE* -OR+ 6MONTH 3Year
0.01
0.01
0.00
0.04
+
30-Sep- 7 7
0.04
0.02
0.05
0.00
+
07-Oct-77
0.06
0.06
0.10
0.21
+
31-Oct-77
0.19
0.26
0.31
0.38
+
09-Jan-78
0.06
0.10
0.14
0.22
+
19-Apr-78
0.01
0.02
0.02
0.09
+
27-Apr-78
0.05
0.05
0.04
0.11
+
18-May-78
0.04
0.04
0.10
0.05
+
21-Jun-78
0.04
0.03
0.01
0.05
+
20-Jul-78
0.09
0.14
0.19
0.23
+
16-Aug-78
-0.01
0.00
0.02
0.07
+
18-Aug-78
0.00
-0.02
0.01
0.09
+
28-Aug-78
0.01
0.01
0.01
0.07
+
08-Sep-78
0.06
0.02
0.03
0.08
+
20-Sep-78
0.04
0.04
0.01
0.02
+
25-Sep-78
-0.01
-0.01
0.00
+ -0.04
28-Sep-78
0.03
0.01
0.04
+ -0.06
18-Oct-78
0.03
0.02
0.03
0.07
+
20-Oct-78
0.04
0.07
0.03
0.12
+
26-Oct-78
0.09
0.23
0.27
+
0.33
31-Oct-78
-0.32
-0.39
-0.28
+
0.09
01-Nov-78
0.00
0.00
0.01
+
0.04
28-Nov-78
0.01
0.00
0.03
0.07
+
19-Dec-78
0.01
-0.01
0.00
+
0.00
15-Jan-79
0.05
0.05
0.12
+
0.29
27-Apr-79
-0.03
0.00
0.04
0.14
+
20-Jul-79
0.03
0.04
0.03
+
0.07
15-Aug-79
0.08
0.08
0.10
0.11
+
24-Aug-79
0.07
0.06
0.13
0.26
+
04-Sep-79
-0.04
-0.07
-0.05
+ -0.25
19-Sep-79
0.04
0.04
0.06
MEAN
0.10
0.03
0.04
0.05
1/ MEAN
0.08
DAY
Fri
Fri
Fri
Fri
Wed
Fri
Thu
END DATE -OR+ 6Month
+
0.38
9-Jan-78
0.07
+
18-Aug-78
+
0.17
22-Sep-78
0.21
+
16-Oct-78
+
0.09
1-Nov-78
0.14
+
20-Jul-79
+
0.05
17-Aug-79
MEAN
0.17
2/ MEAN
0.14
7Year
SYear
3Year
0.26
0.19
0.31
-'0.01
0.00
0.02
0.02
0.00
-0.03
0.11
0.10
0.04
-0.39 -0.32
-0.28
-0.03
0.00
0.04
0.01
0.01
0.03
0.07
0.05
0.07
0.04
0.04
0.01
FORWARD RATES
2OYear 3OYear F(3,2) F(5,2)
0.02
0.00
0.00
0.01
0.11
0.01
-0.03
0.03
0.06
-0.02
0.02
0.02
-0.04
0.17
0.11
0.15
-0.08
0.02
0.02
0.03
-0.02
0.02
0.02
0.02
0.05
0.02
0.06
0.04
0.04
-0.07
0.04
0.04
0.07
0.07
0.01
0.03
-0.08
0.07
0.04
0.08
-0.05
-0.02
-0.03
0.00
0.07
-0.07
0.00
0.01
0.01
0.01
-0.01
0.00
0.19
0.06
0.00
0.07
0.04
0.09
-0.01
0.01
-0.01
-0.03
0.01
0.00
0.10
0.00
-0.05
0.01
0.07
0.00
0.02
0.02
-0.06
0.14
0.03
0.03
-0.38
0.15
0.03
0.02
-0.08
-0.21
-0.59
-0.18
0.00
-0.01
0.01
0.00
0.04
-0.05
-0.02
0.01
0.08
-0.03
0.00
0.00
0.05
-0.07
0.01
0.03
-0.07
0.13
-0.04
-0.01
-0.01
0.05
0.01
0.01
0.08
0.04
0.05
0.04
0.10
-0.07
0.05
0.06
0.06
-0.11
-0.03
-0.02
0.03
0.01
0.02
0.03
0.02
0.01
0.02
0.02
2OYear
0.15
0.00
0.07
0.05
-0.18
-0.01
0.00
0.04
0.04
3OYear
0.11
-0.02
0.06
0.06
-0.21
-0.04
0.00
0.03
0.04
F(3,2) F(5,2)
-0.04
0.17
-0.05
-0.03
0.11
-0.06
0.14
0.21
-0.08
-0.59
-0.14
-0.07
0.01
-0.03
-0.02
0.06
0.03
0.10
DM *
0.35
0.16
0.79
-0.34
-0.25
0.85
1.11
0.17
0.02
-0.98
-0.89
-0.54
-0.84
0.61
0.23
0.15
0.22
1.39
-0.51
-1 .79
-6.85
-0.15
1.04
-0.13
-1.02
-0.34
-0.05
0.00
-0.22
0.56
-0.01
0.07
DM
-0.34
-0.89
0.18
1.04
-6.85
-0.34
-0.06
-0.07
0.39
1/ EXCLUDES DAYS OF DISCOUNT RATE CHANCES AND MONEY ANNOUNCEMENTS
2/ EXCLUDES DAYS OF FUNDS RATE OBJECTIVE CHANCES
"End Date" is the day to which the change in rates
"DM" is the percentage change in the dollar per German mark
*"Date" is the calendar day of the event.
(as of 3:30 p.m.) is calculated.
exchange rate.
- 22 -
announcement occurred.
The average response for the bill rate was 8 basis
points, while the average response for the 30-year rate was 2 basis points.
Discount Rate Announcements Table A5 shows the seven policy or hybrid
announcements that accompanied discount rate changes over the two-year period
prior to October 1979.
The lower panel of Table 4 shows the reaction of
interest rates and the exchange rate to these announcements. 9
The last row
in the lower panel shows the average response across maturities for the three
discount rate changes not accompanied by changes in the funds rate objective.
The average response was 14 basis points for the bill rate and 4 basis points
for the intermediate- and long-term maturities.
Comparison of Rate Movements Following Money Surprises and Funds Rate
Target Changes
We summarize the response of interest rates and the exchange
rate to money announcements and funds rate objective changes with the
regression:
3.
tR= a + b*UMt + c* FFRt + et
where AFFRt is the perceived change in the Federal funds rate objective in
percentage points.20 We do not have an expectations series for changes in the
18On November 1, 1978, a day on which the discount rate was raised
rate objective rose, the Treasury and the Federal Reserve
funds
and the
Board announced a program aimed at supporting the dollar on foreign exchange
markets. The government indicated that it would sharply increase its
available stock of foreign exchange for use in more intensive intervention
activities. The dollar appreciated almost 7 percent against the German
mark. Additionally, while the bill rate rose, intermediate- and long-term
interest, rates fell sharply. Because the discount rate and the funds rate
change occurred on the same day as this announcement, we have excluded it
from the regressions and from the means shown in Table 2.
While many of the discount rate changes were made late in the
the 3:30 daily interest data observation), some were made
(after
afternoon
in the morning. The table also indicates the date of the 3:30 observation
following the announcement.
1 9
The money announcement regression results are not significantly
affected when the Federal funds rate variable is excluded.
2 0
- 23
objective as we do for the money stock release.
However, the regressions do
yield a measure of the average response of rates to a given change in the
funds rate target and indicate whether there was a significant linear relationship between changes in the objective and changes in rates during this
period.
The results are presented in Table 5.l
All spot interest rates rise (fall)
following the announcement of an Ml figure higher (lower) then expected.
The
coefficients in the interest rate regressions from 6 months through 7 years
are significant at the 5% level, while the coefficient in the 3-year ahead
2-year forward rate regression is significant at the 10% level.
The magnitude
of the unexpected money coefficient is largest at the shortest maturities and
declines as maturity increases.
In response to an unanticipated growth in Ml
of 1%, the 6-month rate increases by 4.6 basis points.
figure for the 20-year rate is less than 1 basis point.
The corresponding
The response of the
exchange rate to an unexpected increase in Ml is not significant.
In response to a one percentage point! change in the funds rate objective,
the 6-month bill rate rose about 46 basis points while the 30-year rate rose
about 6 basis points.
The coefficient of the funds rate variable is positive
and significant at the 5% level through the 30-year rate regression. The
coefficient in the two forward rate and the exchange rate regressions is not
significant at the 10% level.
Chart 2 shows the effect of unanticipated money and changes in the funds
rate objective on interest rates of different maturities relative to the effect
on the 6-month rate.
The points plotted are the regression coefficients shown
in Table 5 divided by the 6-month bill rate coefficients.
Overall, the chart
shows that the relative effects of the two types of events on interest rates
in period 1 were similar through the 30-year maturity.
This similarity
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- 24 -
between the pattern of the coefficients of the money announcement and funds
rate target change variables is evidence that, as in period 2, the reaction of
interest rates to money announcements in period 1 was consistent with the
policy anticipations hypothesis.
V.
Period 3 Policy Surprise Data
Federal Reserve statements describe the operating procedures in period 3
as "borrowed reserves targeting." Under these procedures the borrowed reserve
level set at the FOMC meeting is either retained throughout the intermeeting
period or adjusted judgmentally by the Desk in light of incoming information.2 1
If incoming information calls for a higher funds rate, the Desk indirectly
puts upward pressure on the funds rate by raising the borrowed reserves
target.
Although this procedure is conceptually similar to that of period 1,
in practice there were two differences that created more confusion among
market participants regarding Federal Reserve intentions with respect to the
funds rate path than in the previous two periods.
First, even though there
was little trend or cyclical movement in the funds rate in this period, the
week-to-week and intra-weekly movements were quite volatile.
Second, the
relationship between the level of reported borrowing and the spread between
the funds rate and the discount rate was weak.
Hence, market participants
were often confused as to whether a funds rate change signaled a change in the
borrowed reserves target and in the funds rate path or whether it was caused
by a shift in the borrowed reserves function.
funds rate change would be reversed.
If the shift was temporary, the
Even if the shift was permanent, the Fed
For discussion of the operating procedure in this period see
Axilrod [1], Wallich [27] and Gilbert [14].
2 1
- 25
could still choose to subsequently override its effect on the funds rate by
changing the borrowed reserves target.
Open Market Operations Choosing open market operations in period 3 that
fit the criteria outlined earlier for a policy surprise was more difficult
than in the earlier periods and we were able to find only 9 incidents that did
so.
This does not reflect a decrease in interest in daily open market opera-
tions nor does it reflect a decrease in the sensitivity of market rates to
movements in the funds rate.
To the contrary, the Journal credit market
stories in this period reflect intense interest among market participants with
day-to-day movements in the funds rate.
However, these stories generally did
not cite a Fed action or lack of action that caused market participants to
change their perception of the effective funds rate range.
Instead, the
stories simply compared the funds rate toithe prevailing level in previous
days and commented on whether market participants thought the Fed was "easing"
or "tightening." This change in the formlof the Journal's stories appeared to
reflect the substantial confusion in this period about the current stance of
Fed policy and the lack of market consensus as to what the Fed's current
22,
There were scores of stories in
effective range for the funds rate was.
this period that attributed movements in market rates to movements in the
daily funds rate.
However, since these stories did not directly cite a
specific Fed action or lack of action we did not use these incidents.
For each of the open market operation surprises in period 3, Table A6
shows the Journal headline, a relevant quote, and the behavior of rates.
Table 6 summarizes the movement of spot interest rates, forward rates and the
dollar/mark exchange rate on all the policy surprise days in period 3.
22For an example of this confusion, see [11].
As in
TABLE 6
The Movement in Interest Rates and the Exchange Rate
on Policy Surprise Days in Period 3
PERIOD 3
SPOT RATES
3Year 5Year 7Year
-0.06 -0.13 -0.14
0.13 0.04 0.08
0.01 0.05 0.01
0.10 0.07 0.07
0.08 0.05 0.05
-0.04 -0.01 -0.07
-0.09 -0.09 -0.06
-0.04 -0.10 -0.04
0.14 0.14 0.17
0.11 0.08 0.09
-0.04 -0.06 -0.06
2OYear
-0.14
0.14
-0.03
0.08
0.05
-0.01
-0.07
-0.05
0.16
0.11
-0.06
FORWARD RATES
3OYear F(3,2) F(5,2)
-0.21 -0.27 -0.18
0.09 -0.13 0.23
-0.02 0.13 -0.14
0.07 0.02 0.07
0.05 0.00 0.05
0.00 I 0.05 -0.29
-0.08 -0.09 0.05
-0. 08| -0.22 0. 18
0.12 ! 0.14 0.28
0.08 I 0.01 0.16
-0. 08I -0.08 -0.08
0.57
-0.73
0.07
-0.33
-0.42
0.67
-0.64
0.87
0.35
-0.28
0.31
DM"*
DATE*
18-Nov-82
08-Dec-82
09-Dec-82
07-Jun-83
25-Aug-83
19-Sep-83
20-Sep-83
29-Nov-83
06-Jun-84
DAY
Thu
Wed
Thu
Tue
Thu
Mon
Tue
Tue
Wed
END DATE* -OR+ 6Month
- -0.11
16-Nov-62
+ 0.09
08-Dec-82
- -0.04
09-Dec-82
+ 0.14
07-Jurr83
+ 0.11
25-Aug-83
- -0.09
19-Sep-83
- -0.08
20-Sep-83
- -0.02
29-ov-83
+ 0.05
06-Jun-84
AE + 0.10
WAN - -0.07
DATE
19-Nov-82
DISCOUNT
13-Dec-82
RATE
ANUCEENT 21-Nov-84
21-Dec-84
17-Nay-85
DAY
Fri
Mon
Wed
Fri
Fri
END DATE -OR+ 6Monthb 3Year 5Year 7Year 2OYear 3OYear
-0.06 -0.01 -0.11 0.02 0.01 0.08
22-Nov-82
-0.41 -0.27 -0.21 -0.16 -0.15 -0.09
14-Dec-82
-0.12 -0.13 -0.15 -0.14 -0.13 -0.14
23-Nov-84
WA
-0.03 -0.04 -0.04 -0.03 -0.03 -0.02
24-Dec-84
-0.17 -0.27 -0.28 -0.27 -0.27 -0.23
20-May-85
-0.16 -0.11 -0.13 -0. 08 -0.07 -0.04
F(3,2) F(5,2)
-0.31 0.51
-0.09 0.02
-0.19 -0.10
-0.04 0.01
-0.30 -0.23
-0.16 0.11
DM
-0.58
1.39
-0.51
-0.22
1.07
0.02
16-Feb-83
20-Jul-83
06-Feb-84
25-Jul-84
24-Aug-84
20-Feb-85
Wed
Wed
Mon
Wed
Fri
Wed
16-Feb-83
20-Jul-83
06-Feb-84
25-Jul-84
27-Aug-84
20-Feb-85
-0.04
-0.05
0.07
-0.28
0.16
0.15
0.13
-0.12
-0.12 0.06
-0.15 -0.09
0.05 0.04
-0.45 -0.14
0.15 0.23
0.22 0.23
0.14 0.17
-0.24 -0.06
0.72
0.65
-0.25
0.63
-0.61
-0.50
-0.45
0.67
OPEN
MARKET
OPERATIONS
REGLLAR
RELEASES
-0.14
-0.09
0.13
-0.08
WA+
0.19
0.10
lWAN + 0.14
lEAN - -0.10
-0.06
-0.06
0.11
-0.21
0.12
0.10
0.11
-0.11
-0. 08
-0.09
0.09
-0.29
0.13
0.14
0.12
-0.15
-0.05
-0.09
0.08
-0.26
0.15
0.16
0.13
-0.13
-0.06
-0.05
0.09
-0.24
0.18
0.15
0.14
-0.12
*"Date" is the calendar day of the event. "End Date" is the day to which the change in
rates (as of 3:30 p.m.) is calculated. "DM" is the percentage change in the dollar per
German mark exchange rate.
- 26 -
period 2, bond rates virtually always moved in the same direction as the
change in the expected path of the funds rate.
However, unlike in period 2,
there was a number of cases where the movement in rates was flat across the
whole range of maturities, and in some cases long-term rates moved even more
than the bill rate.
Discount Rate Announcements Table A7 provides a record of the five
policy and hybrid discount rate announcements in period 3 and the change in
rates on days of these announcements.
Movements in the bill rate following
policy and hybrid announcements in this period averaged 16 basis points.
In
three cases the pattern of the reaction of intermediate- and long-term rates
was flat, in one case it was declining and in one case bond rates moved in the
opposite direction from the discount rate. 4 The three-year forward rate fell
with the discount rate in all five cases.
The five-year forward rate experi-
enced mixed changes.2 5
Federal Reserve Policy Announcements All five of the semiannual policy
reviews in period 3 were reported by the Journal to have caused a revision in
the market's expectations of the near-term course of monetary policy.
The
3The money announcement data, open market operation surprises and
regressions in this section go through July 1984. We augment the discussion
of discount rate announcements and policy announcements with two discount
rate announcements and two special policy announcements that occurred
between July 1984 and June 1985.
In the one case (November 19, 1982) when the daily change in the
bond rate moved in the opposite direction from the daily change in the
rate, the overnight settle-to-open change in the 20-year bond futures
was in the same direction as the bill rate change. The daily 20-year
rate rose 1 basis point while the settle-to-open 20-year futures rate
1 basis point. (This data is reported in [2]). See footnote 12.
2 4
spot
bill
rate
spot
fell
2 5 The case of November 19, 1982 is an illustration of the wild
swings in forward rates that can occur when combining the Treasury constantmaturity yield series with Shiller's formula. The 3-year, 5-year and 7-year
rates fell 1, 11, and 2 basis points, respectively. As a result, the 3-year
forward rate fell 31 basis points while the 5-year forward rate rose 51
points.
- 27
headlines, relevant quotes, and rate movements are shown in Table A8.
The
reactions to the policy reviews were caused by a variety of circumstances. In
February 1983 the Fed announced increases in the growth rate targets for the
monetary aggregates that Chairman VoIcker stated were "fully compatible with
lower interest rates" as the economy recovers.
According to the Journal, this
announcement was interpreted as indicating that the Fed would not raise the
funds rate in response to the record high growth rate of money in late 1982
and early 1983.
In July 1983 the Fed "rebased" the Ml target using the second
quarter of 1983 and at the same time raisId the target for the second half of
the year to 5 to 9%.
This eliminated almost all of the large gap between the
level of Ml and the upper bound of its target range, thereby reducing expectations that the Fed would raise the funds rate to return money to target.
In
February 1984 the semiannual report contained strong language warning that
deficits would push interest rates up as the expansion progressed, along with
large upward revisions in the money supply for the latter half of 1983.
The
language of the report along with the money supply revisions were viewed as
reducing the chance that the Fed would lower the funds rate in reaction to the
sharp slowing in the growth of money in the latter months of 1983.
At the July 1984 policy review Chairman Volcker made statements that the
market took as indicating the Fed had not tightened at its mid-July FOMC
meeting, as had been widely feared in theldays prior to the review.
When the
July 1984 directive was released in August it indicated that the Fed had in
fact adopted a "tighter" stance than had been anticipated by market participants based on the Chairman's remarks, and the market reaction to the Chairman's July testimony was reversed.
This was the only release of a directive
in period 3 that fit the criteria for a policy surprise. At the February 1985
policy review Chairman Volcker indicated that the Fed had stopped easing credit
conditions the previous month, which, according to the Journal, weakened
- 28 -
expectations among market participants that the Fed would ease further in
order to try to weaken the strong dollar exchange rate.
Table 6 shows that in each of these six cases the rates on all maturities
moved in the same direction as the change in the expected funds rate path.
With one minor exception the change in the 20-year bond rate was at least
one-half that of the bill rate and in two instances it was greater than the
change in the bill rate.
In 11 out of 12 cases the 3-year and 5-year forward
rates moved in the same direction as the policy surprise, and in many cases
the movements were substantial.
Comparison of Rate Movements Following Money Surprises and Open Market
Operations Regressions results for this period of interest rates on unanticipated changes in the money stock and a policy surprise dummy variable are
shown in Table 7.
In these regressions we used only one dummy variable for
all three categories of policy surprises because of the small number of
observations in each category.
The coefficients of unanticipated money in all
the interest rate and forward rate regressions are significant at the 5%
level.
The size of the coefficient in the bill rate regression is much lower
than in period 2 but still well above that of period 1.
The size of the
coefficients in the intermediate-term, long-term and forward rate regressions
relative to the bill rate coefficient is much larger than in period 2.
The
coefficients of unanticipated money in the forward rate regressions are
roughly equal to the coefficient in the bill rate regression.
The regression results for the policy surprise dummy variable show that
both short- and long-term rates reacted to new information influencing the
expected path of the funds rate.
As with the money announcements, the size of
the coefficients of the open market surprise dummy variable is much higher in
the long-term rate regressions relative to the bill rate regression than they
were in period 2.
This is illustrated in Chart 3 which plots both sets of
coefficients as ratios of the six-month bill rate coefficient.
Im
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- 29 -
VI.
Conclusions
In all three periods covered by this paper, the six-month bill rate reacted
strongly to monetary policy surprises that contained new information influencing
the expected path of the funds rate.
the Federal Reserve actions and
The policy surprise data indicate that
statements influencing the expected path of
the Federal funds rate caused real bill rates to change in all three periods.
In period 1 the policy surprise data show a weak response of long-term
rates to new information influencing the expected path of the fund rate.
The
reaction of long-term rates to policy surprises increased in period 2 not only
in absolute magnitude, but also relative to the reaction of short-term rates.
In period 3 the reaction of long-term rates to policy surprises relative to
the reaction of short-term rates again rose.
The policy surprise data indicate
that Federal Reserve actions and statements in period 2 and 3 that influenced
the expected path of the Federal funds rate caused movements in real long-term
interest rates and in real forward rates at least three years into the future.
A typical pattern in period 2 was for a one percentage point movement in the
6-month bill rate in reaction to a policy surprise to be accompanied by a
one-third of a percentage point movement in the 20-year bond rate and in the
three-year forward rate.
The relative reaction of short- and long-term interest rates to policy
surprises in the three periods closely paralleled the relative reaction of
short- and long-term rates to money surprises.
In both cases the relative
reaction of long-term rates rose in period 2 and then rose again in period 3.
We conclude that the reaction of long-term interest rates to money surprises
in the post-October 1979 period was consistent with the reaction of long-term
rates to other monetary policy events that contained information influencing
the expected Federal funds rate path.
The assumption made in some of the
money announcement literature that the reaction of long-term interest rates to
- 30
-I
money surprises in this period was too large to be a reaction to changes in
expectations of the funds rate path is not borne out by the policy surprise
data.
In our view this data solves the "puzzle" posed by earlier authors who
pointed to the reaction of long-term rates as the major, if not the only,
6
evidence inconsistent with the policy anticipations hypothesis.2
The real puzzle in the post-October 1979 period is not why long-term
interest rates were so sensitive to money announcements, but why long-term
interest rates were so sensitive to actual and expected changes in short-term
interest rates.
Broadly speaking, there are two possible explanations.
First,
if the simple expectations theory of the term structure is correct, these
reactions imply that changes in the expected funds rate path influenced
expected real interest rates at least three years into the future in the
post-October 1979 period.
Alternatively, the simple expectations theory of
the term structure may not accurately describe the relationship between
long-term and short-term interest rates in this period.
insight into which of these explanations is correct.
Our paper offers no
It only provides
evidence that changes in the expected funds rate in this period caused
substantial movements in real long-term and forward interest rates.
26
See Cornell [6] and Hardouvelis [15]. Hardouvelis also argues
that the depreciation of the expected future spot exchange rate after a
positive money surprise is a second piece of evidence inconsistent with the
policy anticipations hypothesis. His procedure is to use an open interest
rate parity arbitrage condition to construct a five-year forward exchange
rate, which he then uses as a proxy for the change in the expected spot
exchange rate five years in the future following money announcements. His
conclusion depends critically on his assumption that movement in the premium
component of the forward rate does not vary systematically with the unanticipated component of MI. If this assumption is not valid then his findings
are not evidence against the policy anticipations hypothesis. See Fama [10]
for a discussion of the differential behavior of expected future spot
exchange rates and forward exchange rates.
APPENDIX A:
CALCULATION OF FORWARD RATES
This paper employs forward interest rates calculated using the
methodology discussed in Shiller, Campbell, and Schoenholtz [24].
The
approach accounts for the influence of coupon payments on a bond's effective
maturity, or duration, and is therefore suitable for calculating forward rates
from yield series on spot coupon bonds, such as the constant maturity series
published by the Federal Reserve Board.
The simple linearized approximation to the n period ahead m period
forward rate is
(1)
R (m~n)~ D R(n) )/(D
f(n~m)=(D
m+n
t
n
t
t
m+n
-Dn
n
O.m OSn
where Dm+n and D
are the durations of bonds maturing in m+n and m periods.
Di = (1-g )/(1-g)
g
=
0.i
1f(1+R)
(1 + R) is the discount factor. R is assumed to be equal to the
average of an interest rate over the relevant period.
Rt(m n) and R ( ) are the quoted rates on the m+n and n
period securities at time t.
Durations for a variety of maturities are shown below.
The level of
linearization (R) is the average of the 20 year bond rate for the period
October 8, 1979 to October 11, 1982 (R = 12.63, g=1/(1+R) = 0.887833).
-
Maturity (i)
A2
-
Duration ((l-g )/(l-g))
3
2.68
5
4.00
7
5.04
20
8.10
30
8.66
For yields on securities longer than one year, many studies use the
constant maturity series prepared by the Treasury and published in the Federal
Reserve Board's H.15 and G.13 statistical releases.
Because bonds with the
selective maturities are not continuously available, yields for 1, 2, 3, 5, 7,
10, 20, and 30 years are read from the Treasury's daily yield curve.
The
yield curve is constructed by plotting actual market yields derived from
composite bid prices on actively traded issues.
The curve is made continuous
by drawing a smooth curve through the available points.
Since the constant maturity yields are constructed and do not
necessarily represent actual yields on available securities, it is possible
that small errors are introduced by the construction procedure.
While any
errors may be minor in the spot data, the errors are magnified in the
calculation of the forward rates according to equation (1).
Money announcement studies use the one period change in the forward
rates as the dependent variable in regressions with the unanticipated
component of the Ml announcement as the independent variable.
The one period
change in the forward rate may be written:
(2)
ft+1 (nm)
(n~m)
t~~~lt
=
D
m+n
(R
t+l
(m+nT) - R (m+n) Dt+D (R
(
(~~~~D
n
m+n -D)
(n) - R (n)
t
(
- A3 -
m+n
Rt
,
A random error (e) in Rt+1+n independent of measurement error in
n
n
an error in the change in the forward rate
Rt J,
and Rt, will produce
of:
(D m+n/(D M+n-Dn))*e
For different combinations of m and n, values of D + /(D +
F(n,m)
Dm+n/(Dm+n
F(3,2)
3.03
F(5,2)
4.85
F(20,10)
15.46
-D ) are:
)
The value for F(20,10) indicates that a one basis point error in the 30-year
constant maturity bonds yield produces an error of over 15 basis points in the
change in the 20-year ahead 10 year forward rate.
Assuming that the
measurement error and the equation's disturbance term are independent, then
the estimated coefficients and variances will be unbiased and ordinary least
squares is the proper estimation technique. However, the estimated standard
error of the coefficient will be higher than in the absence of measurement
error.
This makes it more difficult to reject the null hypothesis that the
coefficient on unanticipated money is zero.
extent of the measurement error problem.
We do not have a measure of the
However, we do know that measurement
error will be more severe as the durations of the securities increases.
For
this reason, we have chosen to display data only for the 2 year rates 3 and 5
years ahead.
APPENDIX B:
DO POLICY SURPRISES AFFECT THE MARKET'S EXPECTATIONS OF
SUBSEQUENT MONEY ANNOUNCEMENTS?
In this appendix we discuss the hypothesis that the reaction of
interest rates to the policy surprises documented in this paper occurred
because these surprises changed market expectations of subsequent money
announcements. We describe two possible tests of this hypothesis and carry
out one of these tests.
As background information for these tests it is
useful to review the timing of the expectation surveys and money
announcements. From September 1977 through January 31, 1980 the money market
expectations surveys were carred out on Tuesday and Thursday and the money
announcement was made (late) Thursday.
From February 8, 1980 through February
10, 1984 the expectations survey was carried out on Tuesday and the money
announcement was on Friday.
Since February 16, 1984 the expectations surveys
have been on Friday and Tuesday for the money announcement on the subsequent
Friday.
One test of whether the policy surprises documented in this paper
provided market participants with information that they used to revise their
expectations of the subsequent money release would be to look at the expectations surveys before and after a policy surprise and see whether changes in
expectations were in the same direction as the change in the funds rate path
indicated by the policy surprise.
The only policy surprises that could be
used for this experiment are those that occurred between two expectations
series for the same money release.
We were unable to get both expectations
series for the period before February 1980, and in any case there were only a
small number of policy surprises that occurred on the necessary day (Wednesday).
The next four years there was only one expectations survey.
quently, we were unable to do this exercise.
Conse-
- B2-
A second test of whether the policy surprises documented in this
paper provided market participants with information that they used to revise
their expectations of the subsequent money announcement is to add to the
regressions reported in the paper a dummy variable that takes a non-zero value
on money announcement days when a policy surprise occurred between the Ml
expectations survey day and the money announcement.
The dummy variable is +1
when the policy surprise indicates a higher funds rate path and -1 when the
policy surprise indicates a lower funds rate path.
If Ml estimates are
significantly revised following a policy surprise, then the expected sign for
the dummy variable coefficient is negative since a policy surprise indicating
a higher funds rate would raise the expected Ml figure relative to the
available survey number and lower the actual response of interest rates
relative to the predicted response.
Table BL provides a list of theitwenty-one policy surprises in
period 2 that occurred between the Ml expectations survey day and the money
announcement.* Two policy surprises on consecutive days were in opposite
directions, so we set the dummy variable equal to zero for the money
announcement day following these events.
This left nineteen observations for
which the dummy variable takes on a value of +1 or -1.
The regression results
for the coefficient of the dummy variable are reported in Table B2.
(The
regression results for the coefficients of all the other variables were
virtually unchanged.)
In all but one of the regressions the coefficient of
the dummy variable is not significantly different from zero.
In the five-year
*We only did this exercise for period 2. In period 1 the
expectations survey and the money announcement were on the same day. In
period 3 there were only six policy surprises that occurred between the
expectations survey and money announcement days (excluding surprises on two
consecutive days in opposite directions).i
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TABLE B2
Regression Results for Dumy Variable
Described in Appendix B
6 month
0.61
(0.08)
3 year
0.09
(0.02)
5 year
0.62
(0.13)
7 year
2.48
(0.57)
20 year
3.85
(0.94)
30 year
4.51
(1.18)
F(3,2)
3.03
(0.61)
F(5,2)
9.71**
(1.78)
DM
0.12
(0.60)
aCochrane-Orcutt correction.
**Significant at 10% (2-tailed test).
- B3forward rate regression that coefficient is significant at the 10% level but
has the wrong sign.
Hence, this test provides no support for the view that
the reaction of market rates to policy surprises documented in this paper
reflected a revision in the market's expectations of the subsequent money
announcement.
APPENDIX C:
DATA DESCRIPTION
Interest Rates:
All interest rates are from the Federal Reserve Board's Macro Data
The interest rate series are also published in the Board's G.13
Library.
statistical release.
The six month Treasury bill rate is measured as a bond equivalent
quotes.
yield.
The daily interest rates are derived from 3:30 bid
The bond rates are from the Treasury's constant maturity series.
For all monetary policy events, including the money announcements,
interest changes are measured from the preceding 3:30 observation to the
following 3:30 observation.
If the bond market was closed on the day
following the policy event, the next available observation was used.
Exchange Rates:
The German mark-U.S. dollar exchange rate data for 1977 to 1983 are
taken from various issues of the International Monetary Market Yearbook.
The
daily exchange rate, defined as the price of the German mark in U.S. dollars,
is taken at the 3:00 market close.
The daily change is measured as the
percentage change.
The exchange rate changes for 1984 and 1985 were calculated from
data published in the Wall Street Journal.
Money Supply Data:
MI figures were taken from the Federal Reserve Board's H.6 weekly
release.
From September 29, 1977 to January 31, 1980, the scheduled release
day was Thursday.
From February 8, 1980 to February 10, 1984, the scheduled
release day was Friday.
has been Thursday.
Since February 16, 1984, the scheduled release day
The actual change in Ml in billions of dollars was
- C2-
calculated as the difference between the current week's Ml figure minus the
past week's unrevised MI figure.
For the 10 weeks in which the previous
week's figure was significantly revised due to benchmarking or a change in
definition of MI, the revised figure for the previous week was used.
The consensus predicted change in MI is proxied by the median
estimate from the weekly survey conducted by Money Market Services.
For the
period September 29, 1977 to January 31, 1980, the survey was conducted on
Tuesday and Thursday.
We have used the median from the Thursday survey.
For
the period February 8, 1980 to February 10, 1984, the survey was conducted on
Tuesday.
For the period since February 16, 1984, the survey has been con-
ducted on Friday and Tuesday.
We have used the median from the Tuesday
survey.
The unexpected component of the Ml release is measured by the
difference between the actual change in M1 minus the predicted change in Ml as
a percentage of the previous week's MI figure.
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3.
4.
and
.
"The Reaction of Interest Rates to Unanticipated
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5.
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and Rick Troll.
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