The Identification of the Response of Interest Rates to Monetary Policy Actions Using Market-Based Measures of Monetary Policy Shocks
Federal Reserve Bank of St. Louis Working Paper Series No. 2009-037B
34 Pages Posted: 19 Aug 2009 Last revised: 16 Jun 2012
Date Written: August 18, 2009
Abstract
It has become common practice to estimate the response of asset prices to monetary policy actions using market-based measures such as the unexpected change in the federal funds futures rate as proxies for monetary policy shocks. I show that because interest rates and market-based measures of monetary policy shocks respond simultaneously to all news rather than simply news about monetary policy actions, estimates of the response of interest rates to monetary policy using only monetary policy news measures are biased. I propose a methodology that corrects for this “joint-response bias.” The results indicate that when the bias is accounted for the response of Treasury yields to monetary policy actions is considerably smaller than previously estimated.
Keywords: monetary policy shocks, identification, simultaneity, federal funds target
JEL Classification: E40, E52
Suggested Citation: Suggested Citation
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