The effect of changes in the federal funds rate target on market interest rates in the 1970s
21
Journal of Monetary Economics 24 (1989) 331-351. North-Holland THE EFFECT OF CHANGES IN THE FEDERAL FUNDS RATE TARGET ON MARKET INTEREST RATES IN THE 197Os* Timothy COOK Federul Reserve Bank of Richmond, Richmond, VA 23261, USA Thomas HAHN TKH Associates, San Frannsco, CA 94117. USA Recerved June 1988, final version received July 1989 This paper examines the influence of monetary policy on interest rates by estimating the effect of changes in the federal funds rate target - the Federal Reserve’s policy mstrument - on market interest rates in the 1970s. We find that changes m the target caused large movements in short-term rates and smaller but significant movements in intermediate- and long-term rates. We hypothesize that the similarity of the reactions of three-, six-, and twelve-month rates to changes in the target offers a possible explanation for the lack of support for the expectations theory from studies that have tested the theory using these rates. 1. Introduction The standard empirical test of whether the Federal Reserve can influence interest rates is to regress interest rates on current and past (actual or unexpected) values of money growth. This literature generally finds little support for the view that the Fed can influence interest rates, except perhaps through the positive impact on inflation expectations of increases in money growth. Based on an exhaustive survey of the empirical studies on the impact of money growth on short-term interest rates, Reichenstein (1987, p. 80)’ concludes that ‘the Fed appears to have little control over month-to-month changes in [short-term] interest rates’. This conclusion conflicts with the standard view among participants in the financial markets that the Fed has a strong influence on interest rate move- ments. This view rests on three principles. First, the Federal Reserve’s policy instrument is the federal funds rate. Second, the Fed makes discrete changes in *The authors are grateful to Marvm Goodfnend, Patric Hendershott, Anatoh Kuprianov. and an anonymous referee for many helpful suggestions on this paper. The views expressed in the paper are solely those of the authors and do not necessarily represent those of the Federal Reserve Bank of Richmond or the Federal Reserve System. ‘See this paper for a comprehensive list of references in this literature. 0304-3932/89/$35OCjl989, El sevter Science Publishers B.V. (North-Holland)
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Transcript of The effect of changes in the federal funds rate target on market interest rates in the 1970s
Journal of Monetary Economics 24 (1989) 331-351. North-Holland
THE EFFECT OF CHANGES IN THE FEDERAL FUNDS RATE TARGET ON MARKET INTEREST RATES IN THE 197Os*
Timothy COOK
Federul Reserve Bank of Richmond, Richmond, VA 23261, USA
Thomas HAHN
TKH Associates, San Frannsco, CA 94117. USA
Recerved June 1988, final version received July 1989
This paper examines the influence of monetary policy on interest rates by estimating the effect of changes in the federal funds rate target - the Federal Reserve’s policy mstrument - on market interest rates in the 1970s. We find that changes m the target caused large movements in short-term rates and smaller but significant movements in intermediate- and long-term rates. We hypothesize that the similarity of the reactions of three-, six-, and twelve-month rates to changes in the target offers a possible explanation for the lack of support for the expectations theory from studies that have tested the theory using these rates.
1. Introduction
The standard empirical test of whether the Federal Reserve can influence interest rates is to regress interest rates on current and past (actual or unexpected) values of money growth. This literature generally finds little support for the view that the Fed can influence interest rates, except perhaps through the positive impact on inflation expectations of increases in money growth. Based on an exhaustive survey of the empirical studies on the impact of money growth on short-term interest rates, Reichenstein (1987, p. 80)’ concludes that ‘the Fed appears to have little control over month-to-month changes in [short-term] interest rates’.
This conclusion conflicts with the standard view among participants in the financial markets that the Fed has a strong influence on interest rate move- ments. This view rests on three principles. First, the Federal Reserve’s policy instrument is the federal funds rate. Second, the Fed makes discrete changes in
*The authors are grateful to Marvm Goodfnend, Patric Hendershott, Anatoh Kuprianov. and an anonymous referee for many helpful suggestions on this paper. The views expressed in the paper are solely those of the authors and do not necessarily represent those of the Federal Reserve Bank of Richmond or the Federal Reserve System.
‘See this paper for a comprehensive list of references in this literature.
0304-3932/89/$35OCjl989, El sevter Science Publishers B.V. (North-Holland)
332 T. Cook und T. Huhn, Federal funds rate target changes
its federal funds rate target in reaction to new info~ation affecting its policy decisions, such as money growth rates, inflation rates, unemployment, and foreign exchange rates, and these target changes are highly persistent and seldom quickly reversed. Third, interest rates of longer maturity are deter- mined by the expected level of the funds rate (the one-day rate) over the relevant time horizon (abstracting from default risk). These three principles imply that the Fed influences market rates through its control of the current funds rate and its influence on expected future values of the funds rate.2
A test of this view of the influence of monetary policy on interest rates is to identify Fed actions or statements that signal changes in the funds rate target and then to examine the reaction of interest rates to these signals. An increase in interest rates at a given maturity following a perceived increase in the funds rate target is evidence that the Fed intluences interest rates at that maturity. In this paper we estimate the reaction of interest rates to changes in the funds rate target in the period from September 1974 through September 1979. This period is unique in that the Fed controlled the funds rate so closely that market participants could identify most changes in the funds rate target on the day they were first implemented by the Fed, and these changes were reported in the financial press the following day. We find that changes in the Fed’s funds rate target were followed by large movements in the same direction in short-term interest rates, moderate movements in intermediate-term rates, and small but significant movements in long-term rates.
The reactions of three-month, six-month, and twelve-month Treasury bill rates to changes in the federal funds rate target were very similar. This result indicates that new information influencing funds rate expectations has little effect on the slope of the Treasury bill yield curve from three to twelve months. This result could explain the lack of support for the expectations theory from a number of studies that have tested the theory using rates at these maturities. We discuss this hypothesis below.
2. Federal funds rate target changes
In the 1970s the Federal Open Market Committee (FOMC) at each monthly meeting set an initial target for the federal funds rate and a range over which the funds rate could vary until the next meeting. The FOMC also set tolerance ranges for the growth rates of Ml and M2 over the current and following months, and it issued a set of instructions in the ‘directive’ to the Account Manager at the Federal Reserve Bank of New York (the ‘Desk’) on how to adjust the funds rate within the specified range over the period until the next FOMC meeting. These instructions related desired movements in the funds
“See Goodfriend (1987) for a technical discussion of the feasibility of interest-rate smoothing under rational expectations.
T. Cook und T. Hahn. Federal fundr rate target changes 333
rate primarily to the projected growth rates of Ml and M2 relative to their tolerance ranges, although the Desk frequently was instructed to take other factors into account such as conditions in the foreign exchange markets. In addition to its regular monthly meetings the FOMC had numerous conference calls (or, on occasion, wire votes) that provided additional instructions to the Desk in the period between FOMC meetings. These instructions frequently altered the initial funds rate target range for the period between FOMC meetings, and they often gave the Desk explicit instructions on a new target for the federal funds rate in the days following the call3
Each statement week the Desk set a target for the federal funds rate based on the instructions it had received from the FOMC. As we describe in detail in a working paper (1989) about half of the changes in the funds rate target were determined by the FOMC at its regular meetings or conference calls and the other half were determined by the Desk under its interpretation of the latest FOMC directive. The statement week started on Thursday, but the target for the week was generally set on Friday morning because of the timing of incoming data on Ml and M2. The Desk signaled a new funds rate target to market participants through its daily open market operations. It signaled a higher target, for example. by withdrawing reserves when funds were trading at a rate below the new target or by failing to add reserves when funds were trading at the new higher target. (Actual examples are provided below.) Market participants identified the new target by tracking at what funds rate levels the Desk did or did not supply reserves.
Beginning in late 1974 the Desk’s control of the funds rate became so firm on a day-to-day basis that the public was able to perceive most changes in the
funds rate target on the day they were first implemented. These perceived changes in the target were consistently reported on the following business day in the W&l Street Journal. We used the Journal to compile a record of 76 changes in the target over the period from September 1974 to September 1979. Table 1 shows the old and new funds rate targets on the day of changes in the target, the midpoints of the old and new target ranges. and the size of the target changes. Early in the period the targets were reported as f percentage point ranges. In late 1975 these ranges fell to t percentage point, and by early 1976 the Journal simply announced a point target for the funds rate. Early in the period the target changes were generally 4 percentage point. Beginning in mid-1975 most target changes were a percentage point, although occasionally there were i percentage point changes in the target and toward the end of the period there were three changes of i percentage point.
31n a working paper (1989) we provide a record of the imtial funds rate target, the funds rate range, and the tolerance ranges for Ml and M2 specified at each FOMC meeting, along with a record of the adjustments m the funds rate range and funds rate target made at conference calls between meetings.
Tab
le 1
Fed
eral
fu
nds
rat
e ta
rget
ch
ange
s?
Dat
e
Fu
nds
rat
e ta
rget
s B
ill
rate
s B
ond
rate
s
Day
O
ld t
arge
t M
idpt
N
ew t
arge
t M
idpt
C
han
ge
3mth
6m
th
12m
th
3yr
5Yr
7Yr
1oyr
20
yr
13-S
ep-7
4 F
ri
23-S
ep-7
4 M
on
04-a
ct-7
4 F
li
1%ac
t-74
F
li
03-D
ee-7
4 T
ue
16-D
ee-7
4 M
on
02-J
an-7
5 T
hu
03-J
an-7
5 F
ti
06-J
an-7
5 M
on
07-J
an-7
5 T
ue
14-J
an-7
5 T
ue
31-J
an-7
5 F
n
13-F
eb-7
5 T
hu
14-F
eb-7
5 F
li
21-F
eb-7
5 F
li
26-M
ar-7
5 W
ed
0%M
ay-7
5 T
hu
20-J
un
-75
Fri
16-J
ul-
75
Wed
21-J
ul-
75
Mon
22-J
ul-
75
Tu
e
03-a
ct-7
5 F
li
21-a
ct-7
5 T
ue
07-N
ov-7
5 F
li
11;-
12
11-1
1:
10+
11
10-1
0:
9-9:
8$-9
8i-8
:
8-S
:
7$-8
:
74-8
7-7:
6:-7
:
6i-6
:
6-64
53-6
;
5$-6
5-5:
5-5:
5$-6
:
6:
6-86
’ : 5;
-6,
5;-5
:
11.7
5 11
-11:
11.2
5 lO
i-11
3
10.7
5 10
+10
:
10.2
5 91
-10
9.25
s:
-9:
8.75
8$
-8:
8.50
s-
s:
8.25
7:
-8:
8.00
7$
-8
7.75
7$
-7:
7.25
62
-7:
7.00
6$
-6:
6.50
6-
6:
6.25
5:
-6:
6.00
5$
-6
5.75
5$
-5:
5.25
4:
-5a
5.25
5:
-6
6.00
5:
-6;
6.00
6:
6.
13
6-6:
6.13
5;
-6$
6.00
5:
-5:
5.50
5$
-5:
11.2
5 -0
.500
-0
.31
-0.1
4 -0
15
~ 0
.05
-0.0
4 -0
.03
11.0
0 -
0.25
0 -0
.15
- 0.
08
- 0.
11
- 0.
07
-0.1
1 -0
.14
10.5
0 -
0.25
0 -
0.57
-
0.40
-
0.42
-0
.14
- 0.
09
- 0.
06
9 75
-0
.500
-0
.20
~ 0
.32
-0.3
1 -0
.11
- 0.
10
~ 0
.06
9.00
-
0.25
0 0.
23
-0.1
3 -0
.14
000
0.04
0.
01
8.50
-
0.25
0 -0
.18
-0.1
4 -0
.12
0.00
0.
01
- 0.
04
8.25
-
0.25
0 -
0.17
-
0.09
-
0.06
0.
00
- 0.
02
0.00
8.00
-
0.25
0 -0
.15
-0.1
3 -
0.05
-
0.01
0.
02
0.02
7.75
-
0.25
0 -
0.06
-
0.12
-
0.13
-
0.04
-
0.02
-
0.03
7.50
-
0.25
0 -
0.20
-0
.21
-0.1
2 -
0.03
0.
01
0.01
7.00
-
0.25
0 -
0.20
-
0.21
-
0.02
-
0.03
0.
01
0.04
6.50
-0
.500
-
0.05
-0
.13
-0.1
0 -
0.02
-
0.01
-
0.01
6.25
-
0.25
0 -
0.08
~
0.0
2 -0
.01
~ 0
.04
0.00
0.
03
6.00
-
0.25
0 -0
.18
-0.1
7 -
0.17
-
0.07
-0
.12
-0.1
1
5.75
-
0.25
0 -
0.07
0.
04
0.06
-
0.02
0.
03
- 0.
02
5.50
-
0.25
0 -
0.02
0.
03
0.03
0.
05
0.03
-0
.18
5.00
-
0.25
0 -
0.04
-
0.05
-
0.05
-
0.05
-
0.04
0.
02
5.75
0.
500
0.50
0.
46
0.39
0.
26
0.18
0.
20
6.13
0.
125
0.02
0.
04
0.06
0.
10
0.07
0.
06
6.13
0.
125
0.16
01
6 0.
21
0.04
0.
05
0.04
6.25
0.
125
0.15
0.
12
0.09
0.
04
0.01
0.
01
6.00
-
0.12
5 -
0.20
-
0.21
-0
.33
- 0.
24
-0.2
2 -0
.18
5.63
-
0.37
5 -0
25
-0.1
7 -0
.14
- 0.
12
- 0.
05
- 0.
02
5.38
-0
.125
-0
.14
- 0.
15
- 0.
08
-0.1
5 -0
.10
- 0.
06
-0.1
1
- 0.
02
- 0.
02
0.03
~ 0
.04
0.02
0.01
-0.0
4
- 0.
01
0.03
- 0.
01
0.02
- 0.
09
- 0.
08
- 0.
01
0.02
0.14
0.05
0.01
0.03
-0.1
1
- 0.
02
- 0.
03
0.02
- 0.
07
- 0.
02
-003
0.06
- 0.
01
0.01
- 0.
02
- 0.
03
0.00
0.00
- 0.
03
0.08
-0.1
1
-0.0
6
- 0.
01
-0.0
4
0.05
0.03
0.03
0.00
- 0.
07
- 0.
07
- 0.
01
Tab
le 1
(co
ntm
ued
)
Dat
e
Fu
nds
rat
e ta
rget
s B
ill
rate
s B
ond
rate
s
Day
O
ld t
arge
t M
idpt
N
ew t
arge
t M
idpt
C
han
ge
3mth
6m
th
12m
th
3Yr
5yr
lyr
1Oyr
20
yr
12-N
ov-7
5 W
ed
5:-g
06
-Jan
-76
Tu
e 5;
27
-Feb
-76
Fli
4:
30
-Mar
-76
Tu
e 42
-5;
23-A
pr-7
6 F
ti
4:
05M
ay-7
6 W
ed
4;
12-M
ay-7
6 W
ed
5
14M
ay-7
6 F
ri
5;
19-M
ay-7
6 W
ed
5:
09-J
ul-
76
Fli
51
08-O
tt-7
6 F
ti
5:
19-N
ov-7
6 F
li
5’
14-D
ee-7
6 T
ue
4:
25-A
pr-7
7 M
on
4$-4
!
27-A
pr-7
7 W
ed
4:-4
;
lo-M
ay-7
7 T
ue
5:-5
:
19-M
ay-7
7 T
hu
5:
28-J
ul-
77
ThU
5+
09
-Au
g-77
T
ue
5:
12-A
ug-
77
Fti
5;
09-S
ep-7
7 F
n
6
22-S
ep-7
7 T
hu
6;
30-S
ep-7
7 F
ri
6:
07-a
ct-7
7 F
li
6:,
31-a
ct-7
7 M
on
6:
09-J
an-7
8 M
on
6:
5.38
5+
5;
5.25
5.13
5
5.00
4.75
5
5.00
4.88
4:
4.
75
4.75
4;
4.
88
4.88
5
5.00
5.00
5;
5.
13
5.13
5’
5.25
5:
5.
25
59
5.38
5.50
5.
25
5.25
5
5.00
5.00
4:
4.
75
4.75
4;
4.
63
4.69
4:
-4;
4.81
4.81
4;
-5
4 94
5.19
5:
-5;
5.31
5.25
5;
: 5.
38
5.38
5i
5.
63
5.75
5=
6”
5.88
5.88
6.
00
6.00
6:
6.
13
6.13
6:
6.
25
6.25
6;
6.
38
6.38
6$
6.
50
6.50
6:
6.
63
6.50
6:
6.
75
-0.1
25
0.06
0.
06
-0
125
- 0.
08
-0.1
5
0.25
0 0.
12
0.27
-0.1
25
009
0.09
0.12
5 0.
15
0.11
0.12
5 -
0.01
-
0.01
0.12
5 00
6 0.
10
0.12
5 0.
06
0.12
0 12
5 0.
03
0.05
- 0.
250
- 0.
08
-0.1
2
- 0.
250
-0.1
1 -0
.14
- 0.
250
-0.1
5 -0
.16
- 0.
125
- 0.
04
- 0.
02
0.12
5 0.
00
0.03
0.12
5 -
0.05
0.
02
0.12
5 0.
14
0.10
0.12
5 0.
11
0.18
0.25
0 0.
15
0.15
0.12
5 0.
22
0.16
0.12
5 ~
0.0
1 0.
00
0.12
5 0.
20
0.18
0.12
5 0.
09
0.13
0.12
5 0.
06
0.04
0.12
5 -
0.01
0.
00
0.12
5 0.
18
0.21
0.25
0 0.
41
0.38
0.09
0.
07
0.08
0.
06
0.05
0.
03
- 0.
22
- 0.
05
- 0.
09
- 0.
08
- 0.
10
- 0.
04
021
011
0.09
0.
09
0.09
0.
08
,?
0.05
0.
04
0.03
0.
00
0.01
0.
00
0
0.16
0.
17
0.12
0.
08
0.07
0.
04
g
- 0.
01
0.02
0.
03
0.04
0.
02
0.01
2
0.11
0.
02
0.02
0.
03
0.02
0.
04
;
0 10
0.
06
0 06
0.
04
0 01
-0
.02
2
0.08
0.
04
0.01
0.
02
000
0.01
-0.1
5 -
0.10
-
0.07
-
0.06
_$
- 0.
04
- 0.
03
-0.1
0 -0
.23
-0.1
5 -
0.10
-
0.05
-0
.05
2 &
-0.2
0 -
0.14
-0
.15
-014
-
0.09
-0
.06
$_
- 0.
01
- 0.
02
- 0.
03
- 0.
02
- 0.
01
-0.0
1 3
0.06
0.
06
0.02
0.
04
0.04
0.
02
B
0.07
0.
02
- 0.
01
0.01
0.
00
-0.0
1 $
0.06
0.
03
0.02
0.
02
0.02
0.
01
0.19
0.
10
0.11
0.
06
0.06
0.
04
$
0.13
0.
09
0.07
0.
08
0.05
0.
03
5
0.11
0.
06
0.05
0.
03
0.04
0.
04
2
005
0.01
0.
02
0.01
0
01
0.00
%
0.23
0.
16
0.13
0.
12
0.08
0.
07
0.12
0.
08
003
0.04
0.
03
0.03
0.06
0.
00
0.01
0.
01
0.02
0.
00
0.03
0.
05
0.02
0.
04
0.04
0.
03
0.20
0.
10
0.06
0.
06
0.06
0.
02
0.36
0.
31
0.26
0.
19
0.16
0.
15
E
Tab
le 1
(co
nti
nu
ed)
Dat
e D
ay
Fu
nds
rat
e ta
rget
s B
ill
rate
s
Old
tar
get
Mrd
pt
New
tar
get
Mid
pt
Ch
ange
3m
th
6mth
12
mth
19-A
pr-7
8 W
ed
6:
27-A
pr-7
8 T
hu
7
18-M
ay-7
8 T
hu
7:
21
-Ju
n-7
8 W
ed
7:
20-J
ul-
78
Th
u
12
16-A
ug-
78
Wed
7;
18-A
ug-
78
Fn
8
28-A
ug-
78
Mon
8;
08-S
ep-7
8 F
ti
8:
20-S
ep-7
8 W
ed
8+
25-S
ep-7
8 M
on
8:
28-S
ep-7
8 T
hu
81
18-O
tt-7
8 W
ed
8;
20-O
tt-7
8 F
li
8;
26-O
tt-7
8 T
hu
9
31-O
tt-7
8 T
ue
9:
Ol-
Nov
-78
Wed
9:
28-N
ov-7
8 T
ue
9:
19-D
ec.7
8 T
ue
9;
15-J
an-7
9 M
on
10
27-A
pr-7
9 F
ri
10-1
0:
20-J
ul-
79
Fri
lO
$
15-A
ug-
79
Wed
10
:
24A
ug-
79
FIi
11
04-S
ep-7
9 T
ue
11:
19-S
ep-7
9 W
ed
lli
6.75
7
7.00
7:
7.25
7:
7.
50
71
7.75
7;
7.88
8
8.00
8:
8.
13
8l
8.25
8;
8.38
8:
8.50
8;
8.
63
8:
8.75
8;
8.
88
9
9.00
91
9.13
99
9.50
9:
9.
75
9;
9.88
10
10.0
0 10
;
10.0
6 lo
+-1
0;
10.2
5 10
;
10.6
3 11
11.0
0 11
;
11.2
5 11
;
11.3
8 11
:
7.00
0.
250
0.18
0.
22
0.18
0.
14
0.10
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06
0.05
7.
25
0.25
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13
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02
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250
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75
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125
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00
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125
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09
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03
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06
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63
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01
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000
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125
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004
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50
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250
011
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125
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03
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125
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00
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001
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188
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29
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13
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00
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250
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11
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08
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30
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25
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6 -
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-
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05
Bon
d ra
tes
3yr
5yr
7Yr
1Oyr
20
yr
0.03
0.02
0.04
0.04
0.03
,”
8
0.08
*
0.00
3c
Q
0.00
7
0.00
3
0.07
P
0.
01
3
0.00
0.01
f .q
0.02
0.03
&
s
0.02
P
0.18
$
0.00
I
0.01
2
0.00
00
3 $
- 0.
01
0.01
0.04
0.06
_ - 0.
02
aBil
l an
d bo
nd
rate
ch
ange
s ar
e ca
lcu
late
d ov
er t
he
day
of t
he
targ
et c
han
ges.
T. Cook and T. Huhn, Federal funds rate target changes 331
In a working paper (1988a) we provide a complete record of the headlines and relevant quotations from the Journal stories announcing target changes. An extract from this record is provided in the appendix, which shows the headlines and relevant quotations from the stories announcing the first four target changes, the last four changes, and four changes from around the middle of the period. The Journal quotations describing the target changes generally have two parts. The first part announces that a change in the target has occurred and, in most cases, announces the new target. The second part reports the Federal Reserve action - or lack of action - in the money market that indicated to the public that the target had been changed. This action was reported in all but three cases. The old and new targets are generally based on the quotations from the following day’s Journal, although occasionally we identified the targets from issues of the Jourd other than the day following the target change.
In most cases identifying the old and new funds rate targets from the Journal’s report on the day following a target change was straightforward, although in a few cases some judgment was required. We used the following rules. First, occasionally - especially in late 1974 and the first half of 1975 - the Journal reports the target changes in somewhat speculative lan- guage. For instance. the stories frequently use such language as ‘the Fed may have lowered the target range [3-Dee-741’ or ‘Fed actions.. . appeared to indicate that the Federal Reserve has lowered the target range [4-Ott-741’. We treat these as target changes, and they are almost always confirmed as such in subsequent issues of the Journal. Second, occasionally - especially early in the period - the Journal reports a target change but indicates uncertainty over the new level of the target, using such language as ‘Specialists took yesterday’s injection of reserves as indicating that the Fed prefers to see funds trade in the 5 a’% to 5: % range, or possibly even lower [26-Mar-751’. In such cases we set the new target as that indicated as most likely by the Journal story. These targets are generally confirmed in subsequent issues of the Journal, although there are a small number of cases when the less likely possibility suggested by the Journal turns out to be the new target. Third, on a small number of occasions, when a change in the funds rate target is reported in the following day’s Journal the level of the new target is not specified in that issue of the Journal. In these cases we usually get the new target level from one of the next two issues of the Journaf, although in four instances there is a longer lag before the Journal reports the new target level.
On 21 occasions, almost all of which were prior to mid-1977, the Journal
did not clearly identify the day on which a change in the funds rate target occurred. As a result, there are 21 gaps in the funds rate target series shown in table 1. [Each of these gaps is discussed in a working paper (1988a).]
At the suggestion of a referee, in order to determine the extent of the match between actual changes in the funds rate target and the changes reported by the Journal, we used the Desk’s weekly ‘Report of Open Market Operations’
338 T. Cook and T. Hahn, Federal funds rate target changes
to construct a record of changes in the actual target from September 1974 through September 1979. A sample of this record is shown in table 2. [The complete record is provided in a working paper (1989).] The right-hand side of table 2 shows the Journal reports of changes in the federal funds rate target on Monday August 28 and Friday September 8, 1978. The left-hand side of the table shows the funds rate target chosen by the Desk for the statement week ending on the date shown, and it shows the Desk’s description of its open market activities on those days for which the Journal reported funds rate target changes. The accuracy with which the Journal reported the Desks activities on the two days shown in table 2 was typical of the whole period.
The examples in table 2 illustrate how funds rate target changes were made over this period and how they were identified by market participants. In response to incoming data on the monetary aggregates, the Desk raised the funds rate target for the statement week ending August 30 to Si% from a range of 8% to S$% the previous week. The Desk signaled the new target to the market on Monday, August 28, by allowing federal funds to trade above 8f% before intervening to supply reserves through repurchase agreements. The funds rate target was kept at S$% the week ending September 6. The Desk raised the target to 8+% the week ending September 13 in accordance with decisions made at an FOMC telephone conference on Friday, September 8. The market detected the target change that day when the Fed drained reserves through matched sale-purchase agreements when federal funds were trading at 8:%.
Overall, 71 of the 76 changes in the funds rate target changes in the series we constructed from the Journal can be clearly linked to actual changes announced in the Report of Open Market Operations. Five changes can not be clearly linked. (The five changes were on 14-Feb-75, 16-Jul-75, 30-Mar-76, 26-Ott-78, and 15-Jan-79.) Even in these cases, the Journal accurately re- ported the Desk’s operations, but market participants misunderstood the funds rate target these operations were signaling. We constructed the Journal target series used in this paper prior to our review of the Report of Open Market Operations, and we did not make any changes in the series on the basis of that review because we wanted a series based entirely on market perceptions. This exercise, however, shows that overall these perceptions were
very accurate.
3. Regression results
Table 1 shows the movements on days of changes in the federal funds target in the 3-month, 6-month, and 12-month bill rates, and in the 3-year, 5-year, 7-year, lo-year, and 20-year bond rates, 4 We estimate the response of these
4The Treasury bill rates are converted from discount rates to simple interest rates calculated on a 365-day basis. The bond rates are yields adjusted to constant maturities by the U.S. Treasury All interest rate data are from the Federal Reserve Board’s Macro Data Library.
Tab
le 2
Com
pari
son
of f
unds
rat
e ta
rget
cha
nges
rep
orte
d in
Wal
l S
tree
t .Io
urm
l an
d in
Rep
ort
of O
pen
Mar
ket
Ope
ratio
ns.
---
_- _
__
~_.
. --
...- “_
_ ~_
___~
~ R
epor
t oi O
pen
Mar
ket
Ope
ratio
ns
Wall
Sw
eet
Jour
nui
Rep
ort
I_-~
~ ,
__l-~
-~--
--
Old
tar
get
Rep
ort
is f
or s
tate
men
t w
eek
endi
ng o
n da
te s
how
n In
dent
ed d
ates
des
crib
e D
esk’
s ac
tiviti
es o
n th
at d
ate
Neu
~If~
ne an
d st
ory
New
tar
get
-~~
- A
ugm
~ JO
, 19
78,
In r
espo
nse
to t
hese
dat
a th
e A
ccou
nt
Man
agem
ent
bega
n on
T
hurs
day
IO to
lera
te s
omew
hat fi
ner re
serv
e cond
mon
s,
and
on F
rida
y be
gan
to a
tm f
or c
ondi
tions
as
soci
ated
with
Fed
eral
fun
ds t
radi
ng a
roun
d 8$
%, t
he t
op
of t
he r
ange
spe
cifi
ed b
y th
e C
otnn
ntte
e
Mon
day
Augw
r 28
. Fe
dera
l fu
nds
open
ed
at S
$% a
nd
trad
ed
stea
dily
at
that
ra
te o
ver
the
mor
mng
T
he D
esk
pass
ed t
hrou
gh
the
appr
oxim
atel
y $1
0 bd
hon
of
fore
ign
acco
unt
orde
rs
to
the
mar
ket
as
cust
omer
-rel
ated
re
purc
hase
ag
reem
ents
T
he f
unds
rat
e su
bseq
uent
ly
firm
ed a
nd,
with
fun
ds t
radt
ng
at 8
2 an
d Sf
%.
the
Des
k en
tere
d th
e m
arke
t to
sup
ply
rese
rves
, ar
rang
mg
$1,0
35
nnlh
on
of t
hree
-day
re
purc
hase
ag
reem
ents
Sepr
embe
r 6,
197
8. U
nder
th
e C
omm
ittee
’s m
stru
cnon
s.
the
Acc
ount
M
anag
e-
men
t co
ntm
ued
to s
eek
rese
rve
cond
iuon
s co
nsis
tent
with
a F
eder
al
fund
s ra
te
arou
nd
8$%
. th
e up
per
end
of i
ts r
ange
Sepr
embe
r 13
, 19
78.
In
acco
rdan
ce
wttb
de
cisi
ons
mad
e at
th
e C
omrm
ttee’
s te
leph
one
mee
ting
on F
rida
y [S
epte
mbe
r S]
, the
Des
k be
gan
to a
im f
or a
Fed
eral
fu
nds
rate
of
82%
. with
a r
evis
ed 7
: to
S$%
rang
e of
tol
eran
ce
Fndq
Se
ptem
frer
8
On
Frid
ay
the
Des
k be
gao
to s
eek
slig
htly
tin
ner
mon
ey
mar
ket
cond
itton
s as
soci
ated
w
ith F
eder
al
fund
s tr
adin
g ar
ound
84
%
The
Fe
dera
l fu
nds
rate
op
ened
at
gi
%
and
the
rese
rve
estim
ates
in
dica
ted
that
tr
adin
g w
ould
pra
babl
y re
mam
at
thaf
rat
e tf
the
Des
k Ii
rmte
d tts
ope
ratto
ns
to
mak
ing
mat
ched
sa
le-p
urch
ase
tran
sact
ions
w
ith f
oret
gn
acco
unts
In
ord
er
to
give
e&
x!
to t
he C
omm
ittee
’s d
ecis
ion,
the
Des
k en
tere
d th
e m
arke
t to
abs
orb
rese
rves
, ar
mng
mg
$498
nnl
lion
of o
vert
he-w
eeke
nd
mat
ched
-sal
e pu
rcha
se
tran
sact
tons
T
he f
unds
rat
e ro
se l
o 84
% a
nd l
ater
to
86%
.
Acc
ordm
g to
spe
ctah
srs
who
wat
ch
Fed
oper
auon
s cl
osel
y, t
he n
atio
n’s
mon
ey
man
ager
ap
pear
ed
to b
oost
to
at l
east
R$%
from
8j%
ttb
targ
et m
tere
st r
ate
for
fede
ral
fund
s
The
mdt
catto
n of
a t
ight
er c
redi
t po
hcy
cam
e w
hen
the
Fede
ral
Res
erve
allo
wed
fe
dera
l fu
nds
to t
rade
abo
ve ,
SiS
befo
re l
nte~
enln
g to
cou
nter
act
the
tren
d
But
th
at
behc
f w
as
shat
tere
d w
hen
the
Fede
ral
Res
erve
ga
ve
wha
t m
any
cons
tder
ed
to b
e a
clea
r st
gnal
tha
t it
had
boos
ted
to 8
$% f
rom
8$%
tts
tar
get
rate
on
fede
ral
fund
s
The
Fe
d’s
mdi
cano
n of
ttg
hter
cr
edtt
cam
e w
hen
tt dr
amed
re
serv
es f
rom
the
ba
nkin
g ne
twor
k w
hen
fede
ral
fund
s w
ere
trad
ing
at 8
: %
gj,
8:
g:
8f
-
340 T. Cook und T Hahn, Federui funds rate target changes
Table 3
The effect of funds rate target changes on market interest ratesa
AR,=blib2ARFF;tu,
bl b2 R” SER DW
3-month bill rate 0.016 0.554 0.47 0.13 1.89
(104) (8.10)b
6-month bill rate 0.017 0.541 0.59 0.10 1.82
(1.44) (10.25)b
12-month bill rate 0.024 0.500 0.56 0.10 1.94 (2.02)’ (9.61)b
3-year bond rate 0.018 0.289 0.46 007 1.59 (2.16)’ (7.87)b
5-year bond rate 0.012 0.208 0.36 0.06 1.59 (1.66) (6.43)b
7-year bond rate 0.009 0.185 0.39 005 1.89 (1.47) (6 78)b
lo-year bond rate 0.012 0131 0.32 0.04 1.94 (2.34)’ (5.85)b
20-year bond rate 0.007 0.098 0.29 0.03 2.04 (1.73) (5.46)b
aIncludes 75 changes m the federal funds rate target from September 1974 through September 1979. Bill and bond rate changes are calculated over the day of the target changes. t-statistics are in parentheses.
bSignificant at the 1% level, using a two-tailed test. ‘Significant at the 5% level, usmg a two-tailed test.
rates to changes in the funds rate target with the regression:
(1)
where ARFFr is the change in the funds rate target or in the midpoint of the target range and AR, is the change in the bill or bond rate the day of the target change. An important assumption underlying this regression is that movements in the funds rate target cause movements in other market rates and not the reverse. We discuss this assumption below.
The regression results are shown in table 3.5 The coefficient of the funds rate target change is significant at the 1% level in all the regressions. The magni-
‘We exclude the November 1. 1978 change in the target from the regression. On this day the Treasury and the Federal Reserve announced a program aimed at supportmg the dollar m the foreign exchange markets. The government announced that it would sharply increase its available stock of foreign exchange for use in more intensive intervention activities. On the day of this announcement the dollar appreciated almost 7% against the German mark. Treasury bill rates increased, while intermediate- and long-term rates fell sharply.
T. Cook and T. Hahn, Federalfunds rate target changes 341
tude of the coefficients is fairly stable across the three bill rates and then falls steadily through the 20-year bond rate. Bill rates rose 50 to 55 basis points in response to a 1 percentage point change in the funds rate target. At the long end of the maturity spectrum, the 20-year bond rate rose about 10 basis points for a one percentage point change in the funds rate target.6
As a check of our procedure of using the Journal to identify the day of changes in the funds rate target, we reestimated eq. (1) using daily changes in the 3-month, 6-month, and 12-month bill rates on the two market days before, the day of, and the two market days after the reported target changes. To avoid overlapping of the data, we excluded from the sample those target changes that preceded or followed other target changes by four market days or less. This reduced the sample from 76 to 47 target changes. These regressions are reported in table 4.
As shown in the third row of table 4, the coefficients on the day of the funds rate target changes are very close to those reported for the full sample in table 3. Also, there is little evidence of any systematic movement in bill rates on the day before or two days before the days identified by the Journal as having funds rate target changes, although in the 1Zmonth regression the coefficient is significant at the 5% level with a coefficient of 0.11. The funds rate coefficients in all three regressions on the day following the reported target changes, however, are significant at the 1% level and average a little more than one-third of the coefficients on the day of the reported change. For two days following the reported funds rate target changes, the coefficient in the 6-month bill rate regression is significant at the 5% level, but the coefficients in the other two regressions are not significant and the explanatory power of these regres- sions is nil.
These regression results indicate that at times it took market participants at least a day following the initial Fed action signaling a target change to be completely sure that a change had occurred. The results are consistent with the Journal reporting of the target changes. As illustrated in the appendix, some of the Journal stories reporting a target change had an element of uncertainty. These changes were generally confirmed by the Journal the following day, although in some cases the changes were not confirmed until two or more days following the initial Journal story.
61f market participants understood Federal Reserve signals in this period, then funds rate movements not associated with lastmg target changes should not have caused movements in other market rates. Wednesday is reserve settlement day, and the relatively large movements in the funds rate that day generally are due to end-of-period pressures in the reserve market and have no policy significance. At the suggestion of a referee, we reestimated eq. (1) for the 3-month, 6-month, and 12-month bill rates for all Wednesdays (excluding holidays) over our 5-year sample period. The estimated coefficients were not significantly different from zero, which provides additional confirmation that over this penod market participants were able to distinguish changes in the funds rate target from funds rate movements that carried no policy significance.
342 T. Cook und T. Hahn, Federal funds rate target changes
Table 4
The movement in bill rates on days surrounding funds rate target changes.=
AR,=bl+b2ARFF,+u,
3-month 6-month 12-month
AR, b? R2 b2 R2 b2 R?
Two days before
One day before
Day of target change
One day after
Two days after
0 111 (1.29)
- 0.034 (0.73)
0.559 (6.49)’
0.241 (2.77)’
0.061
(1.00)
0.04 0.041 (0.82)
0.01 0.035 (0.92)
0.48 0.549 (8.14)’
0.15 0.182 (3.59)b
0.02 0.099 (2.61)’
0.01 0 113 0.11 (2.34)’
0.02 0.073 0.06 (1.71)
0.60 0.544 0.59 (8.11)’
0.22 0.185 0.23 (3 63)’
0.13 0.018 0.00 (0.40)
“Includes 47 changes in the federal funds rate target. separated by more than four days, from September 1974 through September 1979. t-statistics are in parentheses.
Significant at the 1% level, using a two-tailed test. ‘Significant at the 5% level, using a two-tailed test.
The interpretation of the regression results in this section rests on the assumption that movements in the funds rate target caused movements in other market rates and not the reverse. We believe this assumption is entirely defensible. As discussed above, the Desk changed the funds rate target in this period either under explicit instructions from the FOMC or under the Desk’s interpretation of the latest FOMC directive. As we document in a working paper (1989), in all but five of the former cases the actual change in the target lagged the FOMC instructions by one or more days, and in about half of the latter cases the market’s perception of a change in the target lagged the Desk’s decision to change the target by at least one day.7 In these cases the reverse causation argument makes no sense because changes in the target initially decided on prior to the day they were reported to have occurred by the Journal could not possibly have been made on the basis of the movement in market rates that day.
In 20 cases the initial decision to change the funds rate target did occur on the day the Journal reported that the target had been changed. In most of the cases the Desk decided to change the target Friday morning and the market interpreted the Desk’s actions that day as signaling a target change. Techni-
‘A lag between the time the Desk decided to change the target and the market’s perception of the target change does not necessarily mean that market participants failed to pick up a clear Desk signal earlier. Although the Desk typically made the deckon to change the target on Friday, it did not necessarily take an action in the market to carry out that decision until later in the statement week.
T. Cook und T. Huhn, Federal funds rate target changes 343
tally, since we are using daily data based on closing market yields, it is
possible to make the argument that these 20 target changes were made in response to changes in market rates from the close the day prior to the target change to the morning of the day of the target change. There is no evidence from the Report of Open Market Operations, however, that overnight changes in market rates were a factor influencing the Desk’s weekly funds rate targets, and there is no reason why the Desk would respond to overnight movements in market rates observed on Friday mornings (when the Desk generally set the funds rate target), but not on other mornings. In any case, we reestimated eq. (1) without these 20 observations and the results were not significantly changed from those reported in table 3.
4. Relevance of regression results for tests of the expectations theory using money market yields
The standard interpretation by market participants of movements in Trea- sury bill rates on days of changes in the funds rate target is that the movements are due to changes in expectations of funds rate levels over the life of the bill. This interpretation of our regression results provides strong support for the expectations theory of the term structure of interest rates. We found similar support for the expectations theory in a related paper on the effect of discount rate announcements on Treasury bill rates [Cook and Hahn (1988b)]. In that paper we distinguished between (1) alignment announcements, which indicate the discount rate is being changed to realign it with market rates, (2) policy announcements, which indicate the discount rate is being changed because of the Fed’s concern over the money supply or other macroeconomic variables, and (3) hybrid announcements, which contain the language of both alignment and policy announcements. We found that throughout the 1973-85 period the Federal Reserve systematically used policy and hybrid discount rate announcements to signal persistent changes in the funds rate. Market partici- pants understood the funds rate signals contained in these announcements and used these signals to revise their expectations of the future path of the funds rate. These revisions in funds rate expectations caused movements in bill rates.
Additional evidence that expectations of the funds rate are a determinant of longer-term money market rates comes from the literature on the effect of money announcements on short-term interest rates. This literature shows a positive reaction of Treasury bill rates at all maturities to announcements of unexpected increases in the money supply. Under the ‘policy anticipations hypothesis’ - which is the most widely accepted explanation for this phe- nomenon - this reaction occurs because the Fed is expected to raise or lower the funds rate in response to deviations of money from its target path.8
‘We argue that the policy anticipations hypothesis is consistent with the reactlon of both short- and long-term interest rates to money announcements in Cook and Hahn (1987)
344 T. Cook and T. Hahn, Federal funds t-ale target changes
The coefficients from the regressions relating changes in Treasury bill rates at different maturities to federal funds rate target changes, policy and hybrid discount rate announcements, and money announcements are summarized in the top part of table 5. A striking aspect of these coefficients is the relative stability from the 3-month through the 12-month maturities. There is no decline in the coefficients of the money announcement regressions and the pre-October 1979 discount rate regressions, and there is only a slight decline in the coefficients of the funds rate regressions and the post-October 1979 discount rate regressions.’ The bottom part of table 5 shows the reaction of the 3-month, 6-month, and 12-month bill rates to the major monetary policy announcements since 1970: (1) the Fed’s October 6, 1979 announcement that it was changing to a ‘nonborrowed reserve’ operating procedure in order to better control the money supply and (2) Chairman Volcker’s October 9, 1982 announcement of the de-emphasis of Ml, which was widely viewed as formally signaling the end of the October 6, 1979 operating procedure. The reaction of rates across the three maturities to these announcements was also stable, with the exception of the relatively weak reaction of the 3-month rate to the October 1982 announcement.
The similarity in the response of bill rates across the 3-, 6-, and 12-month bill rates to federal funds rate target changes, money announcements, discount rate announcements, and monetary policy announcements means new infor- mation influencing expectations of the future level of the funds rate has little effect on the slope of the Treasury bill yield curve from 3 to 12 months. Under the expectations theory, this stable pattern of bill rate responses across these maturities arises if changes in the funds rate target are expected to persist for the subsequent year. It also arises if the funds rate is expected to change in the near future and then stay at its new level for the subsequent year. For example, suppose a discount rate announcement generates expectations of a 50 basis point change in the funds rate the following week, after which no further change in the rate is expected. In such a case under the expectations theory the effect on the slope of the yield curve from 3 to 6 months and 6 to 12 months would be negligible. The difference between the current l-week and l-month rates would be 37 basis points, but the difference between the 3-month and
‘The money announcement coefficients are from Gavin and Karamouzis (1984, p. 30). Roley and Walsh (1985, p. 1015) report almost identical coefficients for the 3-month and l-year rate regressions from October 1979 to October 1982 (0.364 and 0 355), and similar but slightly declining coefficients for the pre-October 1979 period (0.065 and 0.052). Loeys (1985, p. 329) estimates the reaction of the 3-month spot rate and the 3- to 1Zmonth forward rate to money announcements. He reports roughly equal coefficients in the pre-October 1979 period (0.059 and 0.057), slightly declining coefficients in the October 1979 to August 1981 period (0.432 and 0 359). and moderately declining coefficients in the period from December 1981 to December 1983 (0.240 and 0.161).
T. Cook und T. Hahn, Federal funds rate target changes 345
Table 5
The reaction of Treasury bill rates by maturity to events changing federal funds rate expectations.”
3-month 6-month 12-month
(A) Coefinents of Treasur?, brll rate regressrons
Federal funds rate target changes
Sept. 1974-Ott 1979 0.554 0 541 (8.10) (10.25)
Discount rate announcements
Jan 1973-Oct. 1979 0.26 0 32 (2.66) (3 54)
Ott 1979-Dee 1985 0.73 0.61 (7.38) (7.61)
Money announcements
Sept. 1977-Ott 1979 0.072 (3.11)
Oct. 1979-Oct. 1982 0.364 (6.58)
Oct. 1982-Sept. 1984 0.190 (5.77)
0.500 (9.61)
0.30 (3.15)
059 (7.54)
0.072 (4.73)
0.338
(7 59)
0.216
(5 62)
(B) Change rn hril rates followrng major polqa announcements
Oct. 6.1979 announcement 1 20 107 1.15
Oct. 9.1982 announcement - 0.39 - 0.57 -057
“The funds rate target regressron coefficients are from table 3. The 3-month and 6-month discount rate announcement regression coefficients are from Cook and Hahn (1988b). The 12-month discount rate announcement regressions were done for this paper The money an- nouncement regression coefficients are from Gavin and Karamouzis (1984). t-statistics are m parentheses. All brll rate changes are calculated over daily intervals.
6-month rates would be only 2 basis points and the difference between the 6- and 12-month rates would be only one basis point.
The strong evidence that expectations of the future level of the funds rate influence current market interest rates contrasts with the results of a recent
group of papers that have studied the slope of the money market yield curve and found little, if any, support for the expectations theory. The standard test of the expectations theory in these papers is to regress changes in the 3-month rate from period 1 to period t + 1 on the difference between the 6-month and 3-month spot rates in period t (or on the difference between the 3-month forward and spot rates in period t). lo If an unknown but variable term
“Fama (1986). Mankiw and Miron (1986), Mankrw and Summers (1984) Shiller, Campbell. and Schoenholtz (1983) all find that the yield curve from 3 to 6 months has virtually no fore- casting power for the 3-month rate 3 months ahead. Fama (1986) also finds that the yield curve
346 T. Cook and T. Hahn, Federal funds rate target changes
premium is left out of this regression, then in general the greater the propor- tion of the variance of the slope of the yield curve due to the variance of the expected term premium - and the less due to the variance of the expected change in the 3-month rate - the greater will be the downward bias of the slope coefficient from the value predicted by the expectations theory.” As the proportion of the variance of the slope due to interest rate expectations gets very small, the estimated coefficient of the slope approaches zero.
The evidence from table 5 indicates that the slope of the yield curve from 3 to 12 months is not responsive to new information influencing interest rate (i.e., funds rate) expectations. In light of this evidence, it seems quite plausible that the variance of the yield curve over this range is dominated by movements in the term premium. Hence, this evidence offers an explanation for why tests of the expectations theory using rates at these maturities provide so little support for the theory.
5. Conclusion
The data presented in this paper indicate that changes in the federal funds rate target in the 1970s caused large movements in short-term interest rates, moderate movements in intermediate-term rates, and small movements in long-term rates. These results support the standard view among financial market participants that the Federal Reserve has a strong influence on market interest rates through its control of the funds rate.
The evidence from this paper indicates that expectations of the future level of the funds rate strongly influence other money market rates. This evidence in support of the expectations theory is consistent with the evidence from other studies on the effect of monetary policy announcements and money announce- ments on Treasury bill rates. It appears to be at odds, however, with the lack of support for the expectations theory from papers that have tested the theory using short-term interest rates. The insensitivity of the slope of the yield curve from 3 to 12 months to new information influencing funds rate expectations offers a possible explanation for the apparently conflicting results from the two sets of studies.
from 6 to 12 months has no forecastmg power for the &month rate 6 months ahead. Fama (1984), Hardouvelis (1988), and Mishkm (1988) however, find that the yreld curve up to 3 months has forecasting power for the l-month (or 2-week) rate 1 to 2 months ahead. Also, Mankiw and Miron find forecasting power for the yield curve from 3 months to 6 months m the period prior to the foundmg of the Federal Reserve in 1915, and Hendershott (1984) finds forecasting power for the yield curve from 6 to 12 months after adding unexpected changes in inflation and other variables to his estimated equatron.
I1 The bias is a monotonic function of the proportion of the variance of the yield curve due to the variance of the expected term premium only if the correlation coefficient between the expected term premium and the expected change m the 3-month rate is greater than or equal to zero. See Hardouvelis (1988. pp. 342-343) and Mankiw and Miron (1986, pp. 218-220).
T. Cook and T. Hahn, Federal funds rate target changes 347
Appendix
Date
Friday 9/13/74
Monday 9/23/74
Friday 10/4/74
Wal/ Street Journal reports of changes in the federal funds rate target
Headlme Quotation New target Old target
Fed, apparently easing curb on credtt, adds to reserves in
the banking system.
Fed tacttly confirms further easing of credit m tts money- market deahngs
Fed’s apparent credit easing may spur more
prime rate cuts.
perhaps to 11:W.
Friday’s maneuver, dealers’ said, 11-11: 11+-12
indicated the Fed may have lowered its target range on federal funds to the 11% to lli’% vicinity... Over the past three weeks or so, the Fed had used a rate of about 12% on federal funds as a trigger
to inject reserves and about an 11: % rate as a trigger to absorb funds
The hint of the possible new relax- ation came Friday afternoon when the Fed moved to qect reserves into the banking network, which already had appeared to be relatively com- fortable for funds. Specifically. the Federal Reserve injection came when the rate on so-called federal funds
pierced the ll$% level and hit 112%.
The Federal Reserve System tacitly lo:-11: 11-11: confirmed it eased credit another notch through its operations yester- day in the short-term money market.
The nation’s money managers injected funds into the banking system twice yesterday when the federal funds
rate hovered around 11 a % The central bank yesterday injected reserves first when federal funds
were at 11&W, and again when
they traded at ll&%;, dealers said. That prompted specialists to speculate that the maxtmum level at which funds
would be added was dropped to 11 i % , and that funds would be absorbed when
the rate falls to lOa% Only last
week the range was ll$% and 11%.
In recent days it was assumed the lOi-10: lOi-
Federal Reserve preferred to see
funds trade in the 10; % to 11%
range, with the money manager dratmng
reserves when funds went below 105 % and adding them when they traded above 11%. Friday’s actions, the analysts said, appeared to indicate that the Federal Reserve has lowered the current
target range to 10: % to 10: %. or
perhaps even to 10% to 10: %.
348 T. Cook and T. Hahn, Federul funds rate target changes
Date
Wull Sweet Jourrwl reports of changes m the federal funds rate target
Headline Quotation New target Old target
According to money specialists, the Federal Reserve moved Friday to in- tect funds mto the banking system when the rate on so-called federal
funds pressed shghtly above 10: %.
Friday 10/18/74
Thursday 9/22/11
Friday 9/30/77
Frrday 10/l/71
Fed apparently eases credtt rein agam. more banks reduce prtme Interest rates.
Fed acts again to slow growth of money
supply
Even tighter credtt seen as Fed appears to boost federal
funds rate target to
6;%.
Money supply may post another spurt:
Fed expected to tighten credit further
The Federal Reserve System has 95-10 lo-lot apparently eased its credit stance confirmed in another notch As recently as, following day’s a week ago. confirmed in the Journal central bank absorbed funds when the following day’s rate dipped to lo%&, and injected Journal funds at the lot% level. The Fed’s open-market movements will be closely watched this week to deter- mine the new intervention pomts, which many specialists believe wtll
be 9: % to absorb reserves and 10% to iqect them.
The rate on federal funds, or reserves
banks lend each other, fell to 9: % from 10% without any move by the central bank to offset the decline.
Based on Fed market operations yesterday, analysts said it appears the authorities’ target rate on federal funds, a key determinant of short-term interest rates, is
6:%. up from the 6:% set m mid-September.
In yesterday’s trading, the Fed allowed the funds rate to go as
high as 6&S before intervening to pump funds into the market.
The concern over possible tighter credit reins was heightened Friday when the Federal Reserve indicated
it had ratsed to at least 6i%
from 6:‘% its target interest rate on federal funds.
The Fed’s determination was evident Friday when it let federal funds
trade at an mterest rate of 6:%,
66 8 and finally 6: % before taking any offsetting action.
Just last Friday the Fed gave an implicit signal that it had boosted
to 6$% from 6$% its target interest rate for federal funds.
6: 6:
T. Cook und T. Huhn, Federal funds rate target changes 349
Wu// Street Jotcrrrui reports of changes in the federal funds rate target
Headlme Quotation -._.
New target Old target Date
Monday
10/31/77
Wedncs-
day g/15/79
Friday
g/24/79
Tuesday 9/4/79
The Fed clamps a
tight vise on credit and new Treasury note prices plunge.
Fed acts to tighten credit; banks go on to boost prime rate to 12%.
Rise in prune rate
to record 12 $ % seen following move by Fed to tighten
credit
Fed apparently tightens credit;
some rates soar
6; 6t
The Fed gave tacit confirmatton of
the boost to 6+% from 6:% m its funds target by moving to drain reserves from the banking system Friday on two occasions when funds
were trading at the 6i % level.
Specifically, the Fed raised to at
least 62% from 6+% its target interest rate on federal funds. ~
It did so by draimng large amounts of reserves from the banking net- work, first through temporary sales of government securities and then through outright sales of U.S. Treasury btlls Both of yesterday’s maneuvers came when funds were
already trading at 6$%
Just how hrgh the Fed wants interest rates wasn’t immediately clear. But money analysts said the Fed imttally will aim for an interest rate target of about 11% on federal funds, or reserves banks lend one another
The target had been about lo! %.
11 102
The Federal Reserve signaled its tighter credit pohcy by draining reserves from the banking network at a time when federal funds were
trading at 10: %. That indicated it wanted the rate even higher.
The Federal Reserve Board under its
new chairman, Paul A. Volcker, underscored its resolve to battle inflation Friday when it boosted
to about ll{% from 11% its target interest rate on federal funds.
11; 11
The Fed signaled Its latest credit tightening Fnday by allowing the federal funds rate to drift above
ll$% before taking any offsetting actton. Previously. it would have taken counteraction when the rate pressed beyond 11%.
The Federal Reserve System apparently 112 11: tightened its credtt spigot by
boosting to 11 i % from 1 1 $58 its target Interest rate on federal ^ . funds
350 T. Cook und T. Hahn, Federul funds rate target changes
Date
UhN Streer J our& reports of changes in the federal funds rate target
Headhne Quotation New target Old target
The indication of a tougher credit policy came when the Fed allowed
funds to trade at 11:s without taking overt action to temper the rate rise. Indeed, the Fed waited
until funds htt ll:% before inJecting reserves.
Wednes- Fed indicates tt
day wants credit to
9/19/79 get tighter.
Yesterday’s action indicated a Fed
increase to 11:W from lli% in the target interest rate on federal funds, reserves that banks lend each other.
To accomplish this, the Fed drained reserves from the banking network
whtle funds were trading at 11: %
ll$ 11%
References
Cook. T. and T Hahn, 1987, The reaction of interest rates to unanticipated Federal Reserve acttons and statements: Implications for the money announcement controversy, Economic Inquiry 25. 511-534.
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