Federal Reserve Actions Research Articles

Interpreting the Unconventional U.S. Monetary Policy of 2007–09

This paper reviews the unconventional U.S. monetary policy responses to the financial and real crises of 2007–09, dividing these responses into three groups: interest rate policy, quantitative policy, and credit policy. To interpret interest rate policy, it compares the Federal Reserve's actions with the literature on optimal policy in a liquidity trap. This comparison suggests that policy has been in the direction indicated by theory, but it has not gone far enough. To interpret quantitative policy, the paper reviews the determination of inflation under different policy regimes. The main danger for inflation from current actions is that the Federal Reserve may lose its policy independence; a beneficial side effect of the crisis is that the Friedman rule can be implemented by paying interest on reserves. To interpret credit policy, the paper presents a new model of capital market imperfections with different financial institutions and roles for securitization, leveraging, and mark-to-market accounting. The model suggests that providing credit to traders in securities markets is a more effective response than extending credit to the originators of loans.

More Money: Understanding Recent Changes in the Monetary Base

The financial crisis that began in the summer of 2007 took a turn for the worse in September 2008. Until then, Federal Reserve actions taken to improve the functioning financial markets did not affect the monetary base. The unusual lending and purchase of private debt was offset by the sale of Treasury securities so that the total size of the balance sheet of the Fed remained relatively unchanged. In September, however, the Fed stopped selling securities as it made massive purchases of private debt and issued hundreds of billions of dollars in short-term loans. The result was a doubling of the size of the monetary base in the final four months of 2008. This article discusses the details of the programs that the Fed has initiated since the crisis began, shows which programs have grown as the monetary base grew, and discusses some factors that will determine whether this rapid increase in the monetary base will lead to rapid inflation.

Preventing a Repeat of the Money Market Meltdown of the Early 1930s

This paper analyzes the meltdown of the commercial paper market during the Great Depression, and relates those findings to the recent financial crisis. Theoretical models of financial frictions and information problems imply that lenders will make fewer noncollateralized loans or investments and relatively more extensions of collateralized finance in times of high risk premiums. This study investigates the relevance of such theories to the Great Depression by analyzing whether the increased use of a collateralized form of business lending (bankers acceptances) relative to that of non-collateralized commercial paper can be econometrically attributable to measures of corporate credit/financial risk premiums. Because commercial paper and bankers acceptances are short-lived, they are more timely measures of the availability of short-term credit than are bank or business failures and the level or growth rate of the stock of bank loans, whose maturities were often longer and were renegotiable. In this way, the study adds to the literature on financial market frictions during the Great Depression, which aside from analyzing securities prices, typically investigates the behavior of credit-related variables that lag current conditions, such as bank failures, bankruptcies, the stock of money, or outstanding bank loans. ; In particular, the real level of bankers acceptances and their use relative to noncollateralized commercial paper were strongly and positively related to spreads between corporate and treasury bond yields. Also significant were short-run events, such as the October 1929 stock market crash and the 1933 bank holiday episode that sparked flights to quality in the bond market and a flight to collateral (BAs) in the money market and perhaps away from the loan market. Furthermore, these shifts in the composition of external finance were large, supporting the view that financial frictions and reduced credit availability may have played an important role in depressing the U.S. economy during the 1930s. ; The paper also relates these findings to the current financial crisis by examining how the relative use of commercial paper reacted to yield spreads during the current crisis, taking into account Federal Reserve actions to improve liquidity conditions in the money markets. Results suggest that these efforts may have, at least so far, helped prevent the commercial paper market from melting down to the extent seen during the early 1930s.

Analysis of the Interest Rate Sensitivity of Common Stocks

The association between interest rate changes and stock returns has long been of interest to investors, all the more so recently as investors and the financial and popular press have zeroed in on the effect of Federal Reserve actions on interest rates. The interest rate sensitivity of common stocks can be measured using an alternative specification of duration, empirical duration, a measure that has become accepted by fixed-income analysts and portfolio managers. Analysis of the interest rate sensitivity of the aggregate stock market considers alternative economic sectors and many industries and stock indexes that reflect different sizes and investment styles. Five important results are documented: 1) dramatic changes over time in the empirical duration of common stocks; 2) substantial differences in the total-period empirical duration for different economic sectors and different industries; 3) a significant negative relation between market risk and interest rate risk for different industries; 4) significantly different patterns of empirical duration over time for different sectors and industries; and 5) differences in interest rate sensitivity for various economic sectors, industries, and investment styles that are generally consistent with economic expectations. <b>TOPICS:</b>Security analysis and valuation, legal/regulatory/public policy

Yield Curve Conundrum

Shape of Yield Curve and Industry Group Performance It is widely expected that the Federal Reserve will end the current tightening cycle early in 2006. Federal Reserve actions have a direct influence on short-term interest rates, which in turn may impact long-term rates. Long-term interest rates are influenced by (1) investors' expectation of future interest rates, (2) the risk premium demanded to hold long-term bonds, and (3) supply and demand for long-term Treasuries. We attempt to understand the impact of changes in the yield curve on the S&P 500 industry groups' performance. Monetary Policy and Equity Performance We analyzed the impact of changes in monetary policy on the equity markets. We observed industry group performance during periods of tightening and easing monetary policy from 1961 through 2005. We also looked at the changes in long-term interest rates versus the first 100-basis-point move in the Fed Funds target rate during easing and tightening periods.

Innovations and Issues in Monetary Policy: Panel Discussion

Martin Feldstein:1 Chairman Alan Greenspan's remarks today give us an opportunity to understand his thinking about monetary policy and about the Federal Reserve's actions during the past 15 years. It was a period of substantial accomplishment that no doubt reflects in considerable measure the views of the Chairman himself. The Fed's primary goal, price stability, has been achieved, with inflation down from 4 percent at the end of the 1980's to about 1.5 percent now. The 2-percentage-point difference between the interest rate on conventional Treasury bonds and on inflation-indexed bonds (TIPS) shows that financial markets expect inflation will remain at about 2 percent for at least the next decade.

The determinants of Federal Reserve policy actions: A re-examination

In an earlier article (Journal of Macroeconomics 19, 1997) we presented estimates of Federal Reserve reaction functions including variables representing economic and political influences. Our goal was to examine the relative importance of political versus economic influences in determining Federal Reserve actions, as well as to see which economic state variables influenced Federal Reserve actions during various time periods. This paper extends our earlier work in three ways. First, we re-estimate the monetary policy reaction functions in our earlier study in a way which obviates possible reverse causation problems and better approximates the information set that was available to the Open Market Committee at the time its decisions were made. Second, we now have five more years of data which allows us to examine the Greenspan years more fully. Third, we divide our sample period, 1965–94, into two sub-periods, pre-1979 and post-1979, to examine the view that the Federal Reserve evidenced greater concern for inflation in the latter sub-period. The essential change from our earlier study is to use the interval between FOMC meetings as our observation rather than a calendar month. This change is shown to have significant effects on the estimated importance of political factors and economic state variables as determinants of Federal Reserve actions.

The Real Estate Asset Allocation Decision: Monetary Policy Implications

Executive Summary. Previous research establishes that Federal Reserve monetary policy influences both stock and bond returns. This research extends past research and shows that similar patterns exist for real estate investment trust returns. We find that the correlation structure of asset returns changes with alternative monetary policy environments. Mean-variance analysis indicates that optimal asset allocations differ dramatically in different monetary policy environments, and that the exposure to real estate should be prominent only in expansive environments. Overall, the findings suggest that investors may wish to realign their portfolios in reaction to, or anticipation of, Federal Reserve actions.

The effect of monetary policy actions on exchange rates under interest-rate targeting

We specify a theoretical model of the exchange-rate response to U.S. monetary policy actions that is capable of explaining a wide range of recent empirical results. We show that the response pattern of spot and expected future exchange rates depends on the predictability of Federal Reserve actions, the persistence of shocks to the economy, and the reaction of foreign central banks to the US monetary policy shock. We also show that the movements of spot and expected future exchange rates in anticipation of a monetary policy change can outweigh the immediate responses at the time of the change.

The 1966 Financial Crisis: a Case of Minskian Instability?

The so-called credit crunch of 1966 has long been recognized as the first significant postwar crisis, and one that required the first important intervention by the Federal Reserve Bank. In the midst of the postwar expansion, the Fed began to fear inflation and tightened monetary policy to the point at which profitability of institutions was threatened. As Minsky argued By the end of August, the disorganization in the municipals market, rumors about the solvency and liquidity of savings institutions, and the frantic position-making efforts by money-market banks generated what can be characterized as a controlled panic. The situation clearly called for Federal Reserve action. The Fed was forced to enter as a lender of last resort to save the muni bond market, which in effect validated practices that were stretching liquidity. As a result of Fed intervention, the economy continued to expand, new practices emerged and were validated, leverage ratios increased, memories of the Great Depression faded, and markets came to expect that big government and the Fed would come to the rescue as needed. That 1966 crisis was only a minor speed bump on the road to Minskian fragility. To some extent, 1966 proved to be the first verification of the financial instability hypothesis that Minsky had been developing since the late 1950s, and the events of that year would stimulate further development of his analysis of the early postwar transition from a robust system toward a fragile system.

Using Federal Funds Futures Rates to Predict Federal Reserve Actions

The federal funds futures rate naturally embodies the market’s expectation of the average behavior of the federal funds rate. But, as the authors explain, analysts cannot attempt to identify Fed policy from the behavior of the federal funds futures rate without making somewhat arbitrary additional assumptions.&nbsp;

Monetary Policy and Financial Market Expectations: What Did They Know and When Did They Know It?

Interest rates sometimes seem to respond to Federal Reserve policy actions in unexpected ways--for example, falling when the Fed tightens monetary policy or rising when the Fed eases policy. In this article, Michael R. Pakko and David C. Wheelock attempt to demystify such responses. They show how trading in the federal funds futures market reveals public expectations of Federal Reserve actions, and how our knowledge of these expectations can help us interpret the behavior of interest rates.

The Reaction of Interest Rates to Unanticipated Federal Reserve Actions and Statements, 1977-1984: Implications for the Money Announcement Controversy

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.

The indicator properties of the St. Louis monetary base

The paper analyzes the indicator properties of the St. Louis monetary base. It is shown that this base includes a reserve adjustment magnitude which leads to a biased measurement of the total direct contribution of Federal Reserve actions to money growth by making the rate of change of the base directly dependent on the behavior of the public and of commercial banks. Finally attention is drawn to an alternative definition of the monetary base, proposed by Frost (1977), which avoids this defect.

Policy intent, policy formulation and policy effectiveness: an appraisal of federal reserve actions

Policy intent, policy formulation and policy effectiveness: an appraisal of federal reserve actions

The Neutralized Money Stock: An Unbiased Measure of Federal Reserve Actions.

The Neutralized Money Stock: An Unbiased Measure of Federal Reserve Actions.

The Money Supply, Interest Rates, and Investment Expenditures

the effects of the money supply and interest rates on sub-aggregates of investment expenditure. General theoretical agreement exists that the monetary transmission process involves portfolio adjustments by various spending units in response to Federal Reserve actions. After a series of portfolio substitutions, the effects of monetary policy are ultimately felt on income and employment. Important differences remain, however, between the monetarist and neo-Keynesian versions with respect to the key variables in the transmission mechanism. Monetarists emphasize that spending units respond to discrepancies between desired and actual money balances by changing their rate of spending. Thus the major variable in the monetary mechanism is the money supply which ultimately affects expenditures on the

I mercati monetari negli Stati Uniti d'America.

The article presents a detailed description of the money markets in the U.S. In recent years, new markets such as bankers’ acceptances, commercial paper, Negotiable Certificates of Deposit and the external extension of the New York market into Euro-dollars have have been established. Despite the growth in some of these markets, however, the main markets in the U.S. remain those in Government securities and Federal funds. It is through these markets that idle money in the U.S. is mobilised and distributed across the country as a whole. In this context, full use is made of correspondent relationships and both the banks and the dealers attempt to tap every possible source of funds. The intensity of this search for new sources of money has had the effect of binding together much more closely the various parts of the financial mechanism and has made it much more sensitive to Federal Reserve action. JEL: E44, E58

An Explanation of Federal Reserve Actions (1933-68)

An Explanation of Federal Reserve Actions (1933-68)

Changing Credit Conditions

A great change has occurred in credit conditions in the past two or three months. Time and savings deposits in commercial banks and other financial intermediaries have risen significantly; the nation’s money supply has stopped declining; most interest rates have declined sharply; and credit has apparently become more readily available. These developments may be most appropriately appraised by comparing recent experience with somewhat longer-run trends and by considering changes in specific factors underlying expansion of money and credit, such as Federal Reserve actions.