Perfecting the Market's Knowledge of Monetary Policy

Abstract

The rational expectations revolution made clear that a complete macro model requires a specification of the government's economic policy. We argue that monetary policy should be conducted in such a way that the market can predict policy actions. An implication of market success in predicting policy actions is that interest rates move ahead of the policy actions, and such a timing relationship may appear to some as the central bank following the market instead of leading it. Another implication of the market predicting policy actions is that nominal interest rate changes provide no useful information to the central bank about the strength of aggregate demand or inflationary expectations. Finally, the failure of the market to predict policy actions reflects a problem that needs to be addressed. We explore the theoretical implications of a monetary policy that is completely specified and perfectly understood by the market. We construct a bare-bones model to illustrate the key concepts. Finally, we conduct an empirical investigation of these issues, especially in the context of monetary policy since 1988 when the establishment of the federal funds future market made available well-defined market information on expectations about Fed policy actions. *We appreciate comments provided by our colleagues at the Federal Reserve Bank of St. Louis, but retain responsibility for errors. The views expressed are ours and do not necessarily reflect official positions of the Federal Reserve System.

U.S. Monetary Policy Surprises and International Securitized Real Estate Markets

“…8 Such practice is well in line with the recent evidence that unanticipated changes in the federal funds rate affect the financial markets while anticipated changes in the federal funds rate have little effect (e.g., Poole and Rasche 2000;Kuttner 2005 andWongswan 2009). Most previous studies on news announcements tend to apply Ordinary Least Squares (OLS) estimator to serve the purpose.…”

The making of US monetary policy: Central bank transparency and the neoliberal dilemma

“…109 Although recent, this literature is voluminous. Representative works are: Blinder et al (2001), Broaddus (2001), Freedman (2002, , Guthrie and Wright (2000), Kohn and Sack (2003), Lange et al (2001), Poole and Rasche (2000), Poole et al (2002), Sellon (2002), and Woodford (2002). 110 FOMC transcripts, January 30-31, 1996, Appendix-Kohn Statement.…”

Monetary Policy Announcements and Stock Returns: Evidence from the Pakistani Market

“…They checked the impact of expected and un-expected interest rates and found that un-expected policy changes have a significant impact on both aggregate and sectoral returns. Poole and Rasche (2000) also used change in FED funds future rate to generate the monetary policy shocks. Rapallo (1998) used a structural VAR model to analyze the impact of monetary policy changes on European stock markets (Holland, Norway, Italy, Germany, Austria, Belgium, France, Spain, Sweden and Switzerland).…”

“…They highlighted the fact that market participants take their financial decisions by considering the expected policy actions. Bernanke and Kuttner (2005), Poole and Rasche (2000), Berument et al (2007), Bredin et al (2005), Gregoriou et al (2009), used Kuttner's (2001) futures methodology where federal funds rate changes were decomposed into expected and unexpected interest rates to analyze the impact of Monetary Policy shocks on US stock returns.…”