Monetary Policy Expectation Errors

80 Pages Posted: 8 Apr 2020 Last revised: 4 Feb 2022

See all articles by Maik Schmeling

Maik Schmeling

Goethe University Frankfurt - Department of Finance; Centre for Economic Policy Research (CEPR)

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department; Centre for Economic Policy Research (CEPR); University of Tuebingen

Sigurd Steffensen

Danmarks Nationalbank (central bank of Denmark)

Date Written: March 12, 2020

Abstract

How are financial markets pricing the monetary policy outlook? We use survey expectations to decompose excess returns on money market instruments into expectation errors and term premia. We find excess returns to be driven primarily by expectation errors, whereas term premia are negligible. Our findings point to challenges faced by investors when learning about the Federal Reserve's response to large, but infrequent, negative shocks in real-time. Rather than reflecting risk compensation, excess returns stem from investors underestimating by how much the central bank would ease policy in response to such rare shocks. We document similar results in an international sample.

Keywords: Expectation Formation, Monetary Policy, Federal Funds Futures, Overnight Index Swaps, Uncertainty

JEL Classification: E43, E44, G12, G15

Suggested Citation

Schmeling, Maik and Schrimpf, Andreas and Steffensen, Sigurd, Monetary Policy Expectation Errors (March 12, 2020). Available at SSRN: https://ssrn.com/abstract=3553496 or http://dx.doi.org/10.2139/ssrn.3553496

Maik Schmeling (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://sites.google.com/site/maikschmeling/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

University of Tuebingen ( email )

Wilhelmstr. 19
72074 Tuebingen, Baden Wuerttemberg 72074
Germany

Sigurd Steffensen

Danmarks Nationalbank (central bank of Denmark) ( email )

Havnegade 5
Copenhagen, 1093
Denmark

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
471
Abstract Views
1,964
Rank
111,764
PlumX Metrics