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Please use this identifier to cite or link to this item: http://arks.princeton.edu/ark:/88435/dsp014x51hj18j
Title: The Impact of Forward Guidance on Market Perceptions of the FOMC Reaction Function
Authors: Paranzino, Anthony
Advisors: Kiyotaki, Nobuhiro
Department: Woodrow Wilson School
Class Year: 2014
Abstract: Since 2008, Federal Reserve policymakers have grappled with problem of attempting to further stimulate the economy while short-term interest rates are at the zero lower-bound. To circumvent the zero lower-bound, the FOMC has engaged in a practice known as forward guidance, where the FOMC publicly states its intentions for future interest rates. The goal of forward guidance is to lower borrowing cost by reducing the market’s expectations of the path for short-term interest rates. My paper evaluates whether different regimes of forward guidance successfully convinced market participants of changes in the FOMC’s policy reaction function. I specifically test whether changes in forward guidance caused market expectations of interest rates to become less responsive to macroeconomic news surprises. If markets did not anticipate interest rates would rise as much given positive economic news, it can be reasonably concluded that the FOMC reaction function is less sensitive to economic surprises. Using fed funds futures and Treasury yields, I construct measures of the market’s expectations of the path for monetary policy. I then estimate how these measures responded differently to macroeconomic news surprises under different forward guidance regimes using regression analysis. My results include three observations. First, my model produces no statistically significant evidence that the introduction of threshold guidance changed market perceptions of the FOMC reaction function. Second, date-based guidance caused interest rate expectations four to five years out to become more sensitive to economic news surprises. Finally, I find weak evidence that FOMC officials speaking about reducing large-scale asset purchases impacted market interpretations of the FOMC reaction function.
Extent: 63 pages
URI: http://arks.princeton.edu/ark:/88435/dsp014x51hj18j
Type of Material: Princeton University Senior Theses
Language: en_US
Appears in Collections:Woodrow Wilson School, 1929-2016

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