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1 – 10 of over 21000The time series of the federal funds rate has recently been extended back to 1928, now including several episodes during which interest rates remained near the lower bound of…
Abstract
The time series of the federal funds rate has recently been extended back to 1928, now including several episodes during which interest rates remained near the lower bound of zero. This series is analyzed, using the method of indirect inference, by applying recent research on bounded time series to estimate a set of bounded parametric diffusion models. This combination uncouples the specification of the bounds from the law of motion. Although Louis Bachelier was the first to use arithmetic Brownian motion to model financial time series, he has often been criticized for this proposal, since the process can take on negative values. Most researchers favor processes such as geometric Brownian motion (GBM), which remains positive. Under this framework, Bachelier's proposal remains valid when specified with bounds and is shown to compare favorably when modeling the federal funds rate.
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This study aims to address the fundamental question on how the major players in the economy dynamically interact with each other: among the central bank, the investors in the bond…
Abstract
Purpose
This study aims to address the fundamental question on how the major players in the economy dynamically interact with each other: among the central bank, the investors in the bond market and the firms and consumers that contribute to the economic growth, who gets information from whom, when and why?
Design/methodology/approach
To answer “who follows whom,” the authors apply a novel technique to examine the lead–lag relations between three time series, the federal funds rate, the treasury yield curve and the gross domestic product (GDP). To investigate “when and why,” the authors combine the lead–lag relations with principal component analysis to cluster economic states that are similar with respect to the eight macroeconomic variables.
Findings
The authors show that during the period 1977–2019, the bond market potentially obtained information from the federal funds rate (61% of the time) and less often (34% of time) from the changes in the GDP. Meanwhile, the funds rate decision by the Federal Reserve seems to lead the economic growth about 63% of the time. The analysis also suggests that the bond market obtained information directly from GDP when unemployment and inflation was high. In addition, the authors find that the federal funds rate was leading the GDP when the GDP deviated from the target value, consistent with the Federal Reserve’s policy of boosting and damping the economy when the GDP growth is low or high, respectively.
Originality/value
This study provides insights into the fundamental questions that have important implications for empirical work on the monetary policy, financial stability and economic activities.
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Albulena Basha, Wendong Zhang and Chad Hart
This paper quantifies the effects of recent Federal Reserve interest rate changes, specifically recent hikes and cuts in the federal funds rate since 2015, on Midwest farmland…
Abstract
Purpose
This paper quantifies the effects of recent Federal Reserve interest rate changes, specifically recent hikes and cuts in the federal funds rate since 2015, on Midwest farmland values.
Design/methodology/approach
The authors apply three autoregressive distributed lag (ARDL) models to a panel data of state-level farmland values from 1963 to 2018 to estimate the dynamic effects of interest rate changes on the US farmland market. We focus on the I-states, Lakes states and Great Plains states. The models in the study capture both short-term and long-term impacts of policy changes on land values.
Findings
The authors find that changes in the federal funds rate have long-lasting impacts on farmland values, as it takes at least a decade for the full effects of an interest rate change to be capitalized in farmland values. The results show that the three recent federal funds rate cuts in 2019 were not sufficient to offset the downward pressures from the 2015–2018 interest rate hikes, but the 2020 cut is. The combined effect of the Federal Reserve's recent interest rate moves on farmland values will be positive for some time starting in 2022.
Originality/value
This paper provides the first empirical quantification of the immediate and long-run impacts of recent Federal Reserve interest rate moves on farmland values. The authors demonstrate the long-lasting repercussions of Federal Reserve's policy choices in the farmland market.
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Violeta Diaz, Harikumar Sankaran and Subramanian Rama Iyer
After a seven-year period of being stuck in the zero lower bound (ZLB) range, the target rate was raised by 25 basis points on December 16, 2015. Prior to the rate hike, the…
Abstract
Purpose
After a seven-year period of being stuck in the zero lower bound (ZLB) range, the target rate was raised by 25 basis points on December 16, 2015. Prior to the rate hike, the important issues that the Federal Reserve dealt with were the magnitude, timing, and the information conveyed by a first-time rate hike from the ZLB period. The purpose of this paper is to use the data from the ZLB period and simulate the impact of an increase in the proxies for the federal funds rate: effective federal funds rate and shadow rate, and measure the impact on the resulting changes in credit default swap (CDS) spreads across 11 industries. Increases in both proxies predict a significant decrease in CDS spreads which is indicative of an economic recovery. This prediction is confirmed by the announcement effect of the actual rate increase on December 16, 2015 and the three subsequent rate increases.
Design/methodology/approach
In the absence of target rate changes in the ZLB environment, the authors use a recursive vector autoregressive (VAR) model to simulate the rate increases in proxies for target federal rate and predict the impact on the economy by observing the reaction in CDS spreads and stock returns across 11 industries.
Findings
The impulse response indicates that an increase of one standard deviation in the effective rate (approximately 25 basis points) results in a statistically significant decrease in the spreads of CDS contracts in 8 of the 11 sectors studied in this research. Similar results obtain for an increase in shadow rate thus providing a robustness check. These results suggest a rate increase from the ZLB period and the resulting dynamics captured in the VAR system is indicative of an economic recovery.
Originality/value
Prior studies have used the event study methodology to evaluate the impact of rate changes on credit spreads. The ZLB environment does not contain data on target rate changes and renders the event study methodology as ineffective. This paper is the first to simulate the implications of a first-time rate increase from the ZLB environment in the context of a recursive VAR model. The results are very helpful to the Federal Reserve of countries experiencing a ZLB environment such as Japan and Europe.
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Jeff Madura and Oliver Schnusenberg
Outlines previous research on the impact of US Federal Reserve policies on market interest rates and returns; and the relationship between interest rates and market returns…
Abstract
Outlines previous research on the impact of US Federal Reserve policies on market interest rates and returns; and the relationship between interest rates and market returns. Investigates these effects over three time periods: Sept 1974‐Oct 1979 (interest rate targeting through the federal funds rate), Oct 1979‐Aug 1987 (reserves targeting using the discount rate) and Aug 1987‐Jan 1996 (interest rate targeting again); using four mathematical models. Discusses the results, which suggest that changes in the relevant federal policy tool have a significant negative effect on equity returns, especially during the first two periods and when the change reverses previous change. Concludes that announcements of changes in policy contain valuable information not already included in share prices.
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The purpose of this study is to contrast the discount and the Fed funds rates since 1990 and the variables that influence these rates. On the basis of quarterly data, since 1990…
Abstract
Purpose
The purpose of this study is to contrast the discount and the Fed funds rates since 1990 and the variables that influence these rates. On the basis of quarterly data, since 1990, the primary determinants of the two policy rates are: the rate of inflation, the unemployment rate and rates on US Treasury securities, i.
Design/methodology/approach
Ordinary least squares models are developed with autocorrelation removed.
Findings
12 per cent level in the Fed funds market rate models. The statistical significance of the coefficient of the spread between long-term and short-term Treasury rates is a projection of a recession one year in the future. The statistical significance of the coefficients for unemployment, one and two quarter the autocorrelation coefficients, adjusted R-square values and Durbin-Watson statistics are similar for the two policy rate models.
Research limitations/implications
The major limitation is that monthly data are not available for further tests.
Practical implications
The two Fed policy rates respond differently to the impacts of inflation, unemployment and yield curve tilts.
Social implications
Expected recessions, reflected by the yield curve are not often anticipated.
Originality/value
The approach and results have a different perspective from the work in most studies involving Federal Reserve policy rates.
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Roger W. Spencer and John H. Huston
This paper examines the thesis that the Federal Reserve adopted a tighter monetary policy in 1994 than economic conditions warranted. The empirical evidence suggests the FOMC did…
Abstract
This paper examines the thesis that the Federal Reserve adopted a tighter monetary policy in 1994 than economic conditions warranted. The empirical evidence suggests the FOMC did react differently to the basic economic indicators than under economic normalcy, but not differently than it would have under similar, prior tight money economic conditions. E52
Previous literature for the relations between the market interest rates and the targeted or target rate of the Federal Reserve paid little attention to Eurodollar market rates…
Abstract
Purpose
Previous literature for the relations between the market interest rates and the targeted or target rate of the Federal Reserve paid little attention to Eurodollar market rates. The present paper attempts to fill this void.
Design/methodology/approach
The study investigates the dynamic relationship between the federal funds rate and three short‐term Eurodollar deposits rates. Cointegration analysis is utilized to examine the long‐run relationships between the short‐run dynamics of the market and targeted rates through a vector error‐correction mechanism.
Findings
The study shows strong evidence that, while the Eurodollar rates and the federal funds rate move together over time regardless of procedural differences in targeting, how they co‐move, especially how they adjust toward long‐run equilibrium, appears to be related to the targeting procedural changes.
Research limitations/implications
Further research should be conducted for the theoretical analysis of strategic interactions between the monetary authority and market participants in the domestic and external financial markets.
Practical implications
The result suggests that the Fed may affect the market interest rates through a policy of changing the federal funds rate target by a “fixed” amount for the foreseeable future. Such a policy has improved the market's ability to predict the size and timing of the changes in the target rate.
Originality/value
The results of the paper give some new insights into the interactions between monetary policy operations and market interest rates, which is of interest to researchers, monetary authorities, and financial market participants.
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Arvind Krishnamurthy and Taft Foster
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…
Abstract
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
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
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Roger W. Spencer and John H. Huston
This paper aims to examine the controversial issue of the extent to which Federal Reserve monetary policy may have contributed to the recent housing crisis and subsequent adverse…
Abstract
Purpose
This paper aims to examine the controversial issue of the extent to which Federal Reserve monetary policy may have contributed to the recent housing crisis and subsequent adverse macroeconomic developments.
Design/methodology/approach
The authors develop a small model that facilitates OLS and VAR estimates of the critical period.
Findings
The empirical results support the claim of John B. Taylor and others who held that monetary policy was excessively stimulative in terms of the low fed funds rate 2002‐2005, but also support the view of Alan Greenspan and others that the linkages between short‐term rates, long‐term rates, and the housing market deteriorated during that decade.
Originality/value
The model includes the Taylor Rule, a housing equation, and a mechanism linking the two relationships. The empirical results support elements of the camp that blames monetary policy for the recent housing crisis, and elements of the opposing camp which limits policy culpability. Specifically, it suggests excessive monetary ease and a structural change (for which the Fed cannot be blamed) in the monetary policy‐housing market linkage that occurred prior to the crisis. The results also support long‐term, prior crisis, channels of influence that run from the state of the economy to fed funds rates to mortgage interest rates to housing prices. A return to normalcy in the housing market should be accompanied by the re‐establishment of these channels.
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