Skip to main content
Article thumbnail
Location of Repository

DRAFT Volatility, Money Market Rates, and the Transmission of Monetary Policy �

By Seth B. Carpenter and Selva Demiralp

Abstract

Central banks typically control an overnight interest rate as their policy tool, and the transmission of monetary policy happens through the relationship of this overnight rate to the rest of the yield curve. The expectations hypothesis, that longer-term rates should equal expected future short-term rates plus a term premium, provides the typical framework for understanding this relationship. We explore the effect of volatility in the federal funds market on the expectations hypothesis in money markets. We present two major results. First, the expectations hypothesis is likely to be rejected in money markets if the realized federal funds rate is studied instead of an appropriate measure of the expected federal funds rate. Second, we find that lower volatility in the funds market, all else equal, leads to a lower term premium and thus longer-term rates for a given setting of the overnight rate. The results have implications for the design of operational frameworks for the implementation of monetary policy and for the interpretation of the changes in the Libor-OIS spread during the financial crisis. We also demonstrate that the expectations hypothesis is more likely to hold the more closely linked the short- and long-term interest rates are

Topics: Monetary transmission mechanism, expectations hypothesis, term premium JEL codes, E43
Year: 2009
OAI identifier: oai:CiteSeerX.psu:10.1.1.352.6778
Provided by: CiteSeerX
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • http://citeseerx.ist.psu.edu/v... (external link)
  • http://www.ecb.europa.eu/event... (external link)
  • Suggested articles


    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.