Abstract
The relation among the federal funds rate and the Federal Reserve's expectations about future values of certain policy relevant variables is considered. The coefficients of this relation are biased (i) when relevant explanatory variables are omitted, (ii) when the included explanatory variables are measured with error, (iii) when the functional form of the relation is misspecified. These biases present obstacles to verifying the conditions for monetary policies to be effective. It is explained how auxiliary variables, called concomitants, can be used to remove some of these biases without assuming that the “true” functional form of the relation is known. An analysis of the US quarterly data on the variables in a reaction function for 1960Q1–2000Q4 is given using our methods with a description of a numerical algorithm for enacting our methods.
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