Interest Rate Targeting and the Dynamics of Short-Term Rates

Pierluigi Balduzzi, Giuseppe Bertola, Silverio Foresi, Leora F. Klapper
1997 Social Science Research Network  
A characteristic feature of U.S. monetary policy has been the active targeting of the overnight fed funds rate by the Federal Reserve. We show that during the 1989-1996 period, in spite of the effective targeting of the overnight fed funds rate, term fed funds rates displayed volatile and persistent spreads from the target. Moreover, the volatility and persistence of these spreads increase with the maturity of the loan. This behavior is consistent with an expectational model of short-term rates
more » ... which accounts for interest rate targeting with predictable and infrequent revisions of the target, on a daily time scale. Our model successfully replicates the stylized fact that the (autoco-)variance of the spreads of term fed funds rates from the target increases with maturity, because longer-term rates reflect more heavily persistent expectations of the next target change. JEL classification: E43, E44, E52.
doi:10.2139/ssrn.1957 fatcat:n6dlmp2u2bcg7l34yxegy4rzvq