Federal Reserve Policy Research Articles

Monetary Policy Uncertainty

We construct new measures of uncertainty about Federal Reserve policy actions and their consequences - monetary policy uncertainty (MPU) indexes. We show that, under a variety of VAR identification schemes, positive shocks to uncertainty about monetary policy robustly raise credit spreads and reduce output. The effects are of comparable magnitude to those of conventional monetary policy shocks. We evaluate the usefulness of our MPU indexes, and examine the influence of Fed communication. Our analysis suggests that policy rate normalization that is accompanied by reduced uncertainty can help neutralize the contractionary effects of the rate increases themselves.

Federal Reserve Policy in an International Context

In the postcrisis period, some foreign policymakers accused the Federal Reserve of engaging in “currency wars” and inadvertently creating “financial spillovers,” arguing that these were especially consequential given the dominant role of the U.S. dollar in international trade and finance. This lecture analyzes these critiques, and argues: (1) little support exists, either theoretical or empirical, for the currency wars claim; (2) the United States and its trading partners should use nonmonetary tools for dealing with spillovers; and (3) the benefits of the dollar standard to the United States and the world are considerably more symmetric than in the Bretton Woods era.

Unconventional monetary policy and the stock market’s reaction to Federal Reserve policy actions

We examine the change in the effect of Federal Reserve’s policy actions on stock returns after the Fed started to use unconventional policy actions. We find that the response of stock returns to monetary policy actions are almost seven times higher after the federal funds rate hit the zero lower bound. We conduct additional analysis to examine the underlying causes of the increase in the impact of monetary policy actions of stock returns. We show that investors rebalance their portfolios towards equity after selling Treasury securities to the Federal Reserve during large scale asset purchases.

MONETARY SHOCKS, POLICY TOOLS AND FINANCIAL FIRM STOCK RETURNS: EVIDENCE FROM THE 2008 US QUANTITATIVE EASING

We extend the work of Bernanke and Kuttner [(2005). What explains the stock market’s reaction to federal reserve policy? Journal of Finance, 60, 1221–1257] by examining the impact of monetary shocks and policy tools on aggregate stock returns as well as the stock returns of financial institutions during the recent period of quantitative easing (QE) in the US. Specially, we test for the effectiveness of a major non-conventional monetary policy tool, the use of special asset purchase programs by the Federal Reserve, in impacting the financial markets. Estimates from vector auto-regression (VAR) analyses show that the impact of both unexpected and expected monetary shocks on aggregate stock returns is magnified several times during periods of QE. In addition, traditional monetary policy tools, like the Federal Funds rate, have no impact on aggregate stock returns, neither leading up to, nor during QE, while our non-conventional policy measure does appear to have some impact. In an extension of our results, we find that unexpected monetary shocks have an increased marginal impact on the stock returns of financial firms during QE. In addition, the stock returns of financial institutions have significant reactions to both changes in non-conventional monetary policy tools and announcements surrounding non-conventional policy actions.

Impact of Fed Tapering Announcements on North African Equity Markets

We propose an empirical evaluation of the transmission of the Federal reserve policy announcements to the equity price indices of three countries: Egypt, Morocco, Tunisia. The results of panel data tests allow us to highlight a significant negative impact of three of the 19 monetary policy events during the study period (01/01/2013-04/15/2015), generally associated with the speech coming after the FOMC’s meeting and not the minutes release. Moreover, the interaction of domestic fundamentals with monetary policy dummies shows that domestic fundamentals with favorable direct effects on equity markets could indirectly increase their vulnerability to announcement effects (negative interaction).

Quantitative Easing in the Great Recession

This case presents financial and macroeconomic data for the United States between 2007 and 2013, a period covering the financial crisis and Great Recession of 2007–2009 and the slow economic recovery from 2009 onward. During this period, the Federal Reserve had set the federal funds rate, its primary monetary policy instrument, near zero and was using additional monetary policy tools to stimulate the economy. One of these additional tools was quantitative easing (QE).Students will use the data provided in the case to examine how financial markets reacted to QE actions by the Federal Reserve and to analyze the potential impact of QE on the macroeconomy.After reading and analyzing the case, students will be able to: Apply the event study methodology to analyze economic effects Recognize how macroeconomic news affects the prices of financial securities Describe the connections between the prices of financial securities and the macroeconomy • Debate the relative costs and benefits of quantitative easing and the optimality of Federal Reserve policy

Crises in Economic Thought, Secular Stagnation, and Future Economic Research

Crises in Economic Thought, Secular Stagnation, and Future Economic Research

Discussion

Discussion

A Structural Model for Optimal Selection of Maturity and Timing of Callable Bond Issuance

A major shortcoming of previous structural models for bonds is that they ignore how the complex terms of a call feature interact with default to determine term structures at issuance. A term structure of par coupon yields is different from and superior to a term structure based on the option-adjusted spread and, furthermore, is the most useful term structure for firms issuing bonds because it is the most accurate measure of the cost of debt. The authors present a par coupon structural model that can be used as an aid in timing bond issues because some parameters of the model have been proven to exhibit predictability. One can use the model to incorporate the impact of alternative future Federal Reserve policies for short-term interest rates upon the optimal timing and maturity of corporate bond issuance. The authors report that par coupon term structures can have shapes distinctly different from other simultaneous term structures, such as those derived from option-adjusted spreads where the difference depends on default risk, alternative call features, and the interaction of default risk and call features. As one finding among many, they find that call option value (at issuance) declines as credit quality declines.

Monetary Policy Implementation and Private Repo Displacement: Evidence from the Overnight Reverse Repurchase Facility

In recent years, the scale and scope of major central banks' intervention in financial markets has expanded in unprecedented ways. In this paper, we demonstrate how monetary policy implementation that relies on such intervention in financial markets can displace private transactions. Specifically, we examine the experience with the Federal Reserve's newest policy tool, known as the overnight reverse repurchase (ONRRP) facility, to understand its effects on the repo market. Using exogenous variation in the parameters of the ONRRP facility, we show that participation in the ONRRP comes from substitution out of private repo. However, we also demonstrate that cash lenders, when investing in the ONRRP, do not cease trading with any of their dealer counterparties, highlighting the importance of lending relationships in the repo market. Lastly, using a confidential data set of repo transactions, we find that the presence of the Fed as a borrower in the repo market increases the bargaining power of cash lenders, who are able to command higher rates in their remaining private repo transactions.

Measuring Cross Country Monetary Policy Uncertainty

In previous work, we constructed a news-based index of U.S. monetary policy uncertainty (MPU) that captures the degree of uncertainty the public perceives about Federal Reserve policy actions and their consequences. In this note, we extend that work to Canada, the Euro Area, Japan, and United Kingdom.

The influence of monetarism on Federal Reserve policy during the 1980s

L’importance du monétarisme au sein de l’histoire de la pensée économique, notamment depuis l’attribution du prix Nobel de sciences économiques à Milton Friedman en 1976 n’est plus à démontrer, mais la question de son influence au sein des institutions économiques reste irrésolue. La littérature secondaire affirme que la Réserve fédérale a mis en œuvre une politique monétaire à partir de 1979. Cependant, selon Friedman [1984], “Though the Federal Reserve System’s rhetoric was “monetarist” the actual policy that it followed was antimonetarist”. Dans cet article, nous proposons une nouvelle interprétation à la lumière d’une analyse de données, mais également en utilisant les témoignages de Paul Volcker et en étudiant les archives de la Réserve fédérale. Nous affirmons que l’influence du monétarisme au sein de la Réserve fédérale a eu une double nature et que la politique mise en œuvre par celle-ci était clairement monétariste, mais que l’échec de cette expérience explique le fait que les monétaristes n’ont jamais considéré que leurs idées ont été appliquées.

The evolution of U.S. monetary policy: 2000–2007

A vector autoregression with time-varying parameters is used to characterize changes in Federal Reserve policy that occurred from 2000 through 2007 and describe how they affected the performance of the U.S. economy. Declining coefficients in the model׳s estimated policy rule point to a shift in the Fed׳s emphasis away from stabilizing inflation over this period. More importantly, however, the Fed held the federal funds rate persistently below the values prescribed by this rule. Under this more discretionary policy, inflation overshot its target and the funds rate followed a path reminiscent of the “stop-go” pattern that characterized Fed behavior prior to 1979.

Uncertainty About Federal Reserve Policy and Its Transmission to Emerging Economies: Evidence from Twitter

It is well known that a tightening or easing of the United States’ monetary policy affects financial markets in emerging economies. This paper argues that uncertainty about future monetary policy is a separate transmission channel. We focus on the taper tantrum episode in 2013, a period with an elevated uncertainty about monetary policy, and use a data set that contains 90,000 Twitter messages (“tweets”) on Federal Reserve tapering. Based on this data set, we construct a new index about monetary policy uncertainty using a list of uncertainty keywords. An advantage of this index is that it reflects uncertainty about a specific policy decision. An estimated vector autoregression (VAR) shows that uncertainty shocks lead to a fall in asset prices and a depreciation of local currencies. We also discuss the policy implications of this uncertainty channel of monetary policy transmission.

Causation and Consequences in Monetary Policy: Are Federal Reserve Policies Based on an Inadequate Theory of Causal Responsibility?

Abstract This article enters the debate among central bankers, finance ministers and monetary theorists regarding the circumstances under which the dominant central bank is properly considered causally responsible for the adverse consequences of its monetary policy actions. Analyzing both the criticisms of the Federal Reserve for its QE (Quantitative Easing) and ZIRP (Zero Interest Rate Policy) policies and the Fed responses, this inquiry uses the categories of philosophers Hart, Honore, Feinberg, Davidson and others to demonstrate the different theories of causation at work and address the question of which idea of causal responsibility is most appropriate in monetary policy contexts.

Monetary Policy Implementation and Financial Stability: Evidence from the Overnight Reverse Repurchase Facility

In this paper, we demonstrate how monetary policy implementation that relies on intervention in financial markets can significantly affect those markets, with potential implications for financial stability. Specifically, we examine the experience with the Federal Reserve's newest policy tool, known as the overnight reverse repo (ONRRP) facility, to understand its effects on the repo market. Using exogenous variation in the parameters of the ONRRP facility, we show that private repo activity is crowded out when repo lenders invest in the ONRRP. Additionally, using a confidential data set of repo transactions, we find that the presence of the Fed as a borrower in the repo market increases the bargaining power of cash lenders, leading to increased funding costs for borrowers. Lastly, we show that repo borrowers do not decrease their total repo borrowing in response to this adverse funding shock, but rather shift to repo backed by riskier collateral types and borrow more from lenders ineligible for the ONRRP, both of which could lead to more instability in dealer funding.

Federal reserve's policy, global equity markets, and the local monetary policy stance

This paper examines the extent to which local monetary policy stance determines the strength of US monetary policy international transmission to global equities. Using a sample of 35 countries, we document that US monetary policy surprises exert significant inverse effects on global equity returns. Our results suggest that countries whose policy rates are brought into line with that of the US are less sensitive to US monetary policy shocks only when they have a high and intermediate level of cross-border financial linkages, and only when they have a low and intermediate level of exchange rate volatility.

“We Must Deflate”: The Crime of 1920 Revisited

Post-World War I Federal Reserve System policy focused on reducing price levels. Faith in liquidationist ideas led Federal Reserve officials to maintain tight-money policies during the depression of 1920–1921. Farmers suffering through this economic crisis objected to contemporary monetary policy. Organized labor and leading Progressive reformer Robert M. La Follette Sr. seconded their criticism. Postwar challenges to the nation’s financial leadership and its priorities bore tangible results by producing a number of notable reforms, including modifications of Federal Reserve policy and the Agricultural Credits Act of 1923. In the absence of similar political pressure during the Great Depression, the Federal Reserve System adhered to liquidationist ideas and did not pursue monetary expansion.

THE BEHAVIORAL CHARACTERISTICS OF VELOCITY MAY SOON LEAD TO A RISE IN INFLATION

ABSTRACT The Federal Reserve's accommodative policy response to the Great Recession has left many wondering if inflation will rear its destructive head in the near future. In fact, the Quantity Theory of Money predicts that a rise in the money supply will result in an increase in prices. But, this theory is controversial. Some economists argue that the Velocity of money may be variable and thus can influence changes in the level of prices. Others argue that Velocity is constant and that over the long-run an increase in the money supply will inevitably lead to an increase in the level of prices. This study reviews the current measurements of the Quantity Theory of Money and attempts to provide a framework for understanding the impact of certain behavioral characteristics of consumer saving and spending not accounted for in the theory. Keywords Quantity Theory of Money, Inflation

Market Set‐up in Advance of Federal Reserve Policy Rate Decisions

textabstractThis paper considers the uncertainty associated with upcoming Federal Open Market Committee (FOMC) announcements and the extent to which participants in the fed funds futures market prepare for such announcements before they actually occur. We demonstrate that markets set up well in advance of known announcement days, going back as far as six months prior to an FOMC meeting. As a result, there is often less variation in fed funds futures prices in the period immediately preceding an FOMC announcement, despite greater volume of activity, as the market has already incorpo- rated anticipated signals. We find that macro announcements and central bank officials’ speeches and congressional testimony are of comparable importance. In addition, while macro announcements have stronger effects when they are released during the Fed’s “blackout” period, congressional testimony is more important when it coincides with days when important macro variables are released.