The response of interest rates to monetary and financial announcements

Date

1989-08

Journal Title

Journal ISSN

Volume Title

Publisher

Texas Tech University

Abstract

The academic literature on market responses to weekly Federal Reserve announcements of the money stock has shown that money surprises have an effect on short-term interest rates. Most of the existing evidence is based on the Lagged Reserve Requirements (LRR) system. However, in 1984, the Federal Reserve shifted to a new Contemporaneous Reserve Requirements (CRR) system which has allowed us to further investigate the effects of monetary and financial announcements on financial markets. Previous studies have shown that the response of short-term interest rates to money announcements diminished after the implementation of the CRR system, and the change in the emphasis placed by the Federal Reserve on money targets. If this effect holds, two different possibilities are available: short-term rates could respond to other monetary or financial announcements, namely the monetary base. Additionally, short-term rates could respond to announcements of another indicator of economic activity, namely business loans. The dissertation provides empirical tests of these arguments. Also, this dissertation provides empirical tests of the impact of two alternative measures of the monetary base. Previous studies show that the two measures have a different effect on financial markets.

The empirical analysis uses weekly interest rate data and weekly financial and monetary announcement data from October 1982 to December 1987. The interest rate information, sampled before and after the monetary announcement, was provided by Telerate (or taken from the Federal Reserve H.15 release). The money stock, monetary base, and business loan announcement data was obtained from the U.S. Financial Data published by the Federal Reserve Bank of St. Louis and the Federal Reserve H.3 release. The basic hypotheses tested are as follows:

  1. Innovations in the monetary base have no impact on short-term interest rates following the CRR system implementation.
  2. Innovations in the monetary base at the end of each reserve maintenance period have the same effect on interest rates as innovations in the monetary base in the middle of each reserve maintenance period.
  3. Innovations in business loans as they are announced on a weekly basis, have no impact on short-term interest rates.
  4. Business loan announcements and commercial paper announcements have a similar effect on short-term interest rates.

The study uses univariate time series models to decompose any weekly monetary/financial announcement into its expected and unexpected elements. Market efficiency arguments suggest only the unexpected information in a public release, innovations, should effect financial asset prices. Regression models are used to measure the response of interest rates to monetary/financial announcements.

Overall, the empirical results are mixed on whether interest rates respond to alternative monetary/financial announcements. Innovations in the monetary base do not seem to affect short-term rates after the implementation of the CRR system. The two alternative measures of the monetary base do not seem to have a different effect on financial markets. Innovations in the monetary base seem to have a different effect on rates depending when, during the maintenance period, they are announced. Business loan announcements and commercial paper announcements do not seem to have a different impact on short-term rates. Innovations in business loans do not seem to have a significant effect on rates but, innovations in commercial paper seem to affect rates.

Description

Keywords

Interest rates -- Effect of money supply on, Interest rates -- Effect of economic policy on

Citation