Let’s twist again: a high-frequency event-study analysis of operation twist and its implications for QE2

This paper undertakes a modern event-study analysis of Operation Twist and compares its effects to those that should be expected for the recent quantitative policy announced by the Federal Reserve, dubbed "QE2". We first show that Operation Twist and QE2 are similar in magnitude. We identify six significant, discrete announcements in the course of Operation Twist that potentially could have had a major effect on financial markets, and show that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significant but moderate, amounting to about 15 basis points. This estimate is consistent both with Modigliani and Sutch’s (1966) time series analysis and with the lower end of empirical estimates of Treasury supply effects in the literature.Monetary policy

Real wage cyclicality in the PSID

Previous studies of real wage cyclicality have made only sparing use of the microdata detail that is available in the Panel Study of Income Dynamics (PSID). The present paper brings to bear this additional detail to investigate the robustness of previous results and to examine whether there are important cross-sectional and demographic differences in wage cyclicality. Although real wages were procyclical across the entire distribution of workers from 1967 to 1991, the wages of lower-income, younger, and less-educated workers exhibited greater procyclicality. However, workers' straight-time hourly pay rates have been acyclical, suggesting that more variable pay margins such as bonuses, overtime, late shift premia, and commissions have played a substantial if not primary role in generating procyclicality.Wages ; Labor market

Futures prices as risk-adjusted forecasts of monetary policy

Many researchers have used federal funds futures rates as measures of financial markets' expectations of future monetary policy. However, to the extent that federal funds futures reflect risk premia, these measures require some adjustment. In this paper, we document that excess returns on federal funds futures have been positive on average and strongly countercyclical. In particular, excess returns are surprisingly well predicted by macroeconomic indicators such as employment growth and financial business-cycle indicators such as Treasury yield spreads and corporate bond spreads. Excess returns on eurodollar futures display similar patterns. We document that simply ignoring these risk premia significantly biases forecasts of the future path of monetary policy. We also show that risk premia matter for some futures-based measures of monetary policy shocks used in the literature.Federal funds rate ; Federal funds market (United States) ; Monetary policy

Examining the bond premium puzzle with a DSGE model

The basic inability of standard theoretical models to generate a sufficiently large and variable nominal bond risk premium has been termed the "bond premium puzzle." We show that the term premium on long-term bonds in the canonical dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to the data. We find that introducing long-memory habits in consumption as well as labor market frictions can help fit the term premium, but only by seriously distorting the DSGE model's ability to fit other macroeconomic variables, such as the real wage; therefore, the bond premium puzzle remains.Interest rates ; Econometric models

The bond premium in a DSGE model with long-run real and nominal risks

The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data - an example of the "bond premium puzzle." However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors face long-run economic risks and have recursive Epstein-Zin preferences. We show that introducing these two elements into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables.

Does inflation targeting anchor long-run inflation expectations? evidence from long-term bond yields in the U.S., U.K., and Sweden

We investigate the extent to which inflation targeting helps anchor long-run inflation expectations by comparing the behavior of daily bond yield data in the United Kingdom and Sweden--both inflation targeters--to that in the United States, a non-inflation-targeter. Using the difference between far-ahead forward rates on nominal and inflation-indexed bonds as a measure of compensation for expected inflation and inflation risk at long horizons, we examine how much, if at all, far-ahead forward inflation compensation moves in response to macroeconomic data releases and monetary policy announcements. In the U.S., we find that forward inflation compensation exhibits highly significant responses to economic news. In the U.K., we find a level of sensitivity similar to that in the U.S. prior to the Bank of England gaining independence in 1997, but a striking absence of such sensitivity since the central bank became independent. In Sweden, we find that forward inflation compensation has been insensitive to economic news over the whole period for which we have data. Our findings support the view that a well-known and credible inflation target helps to anchor the private sector's perceptions of the distribution of long-run inflation outcomes.Inflation (Finance) ; Prices ; Monetary policy

Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements

We investigate the effects of U.S. monetary policy on asset prices using a high-frequency event-study analysis. We test whether these effects are adequately captured by a single factor-changes in the federal funds rate target - and find that they are not. Instead, we find that two factors are required. These factors have a structural interpretation as a "current federal funds rate target" factor and a "future path of policy" factor, with the latter closely associated with Federal Open Market Committee statements.We measure the effects of these two factors on bond yields and stock prices using a new intraday data set going back to 1990. According to our estimates, both monetary policy actions and statements have important but differing effects on asset prices, with statements having a much greater impact on longer-term Treasury yields.Monetary Policy; Asset Prices; Factor Analysis; Multi-dimensional Policy

The Bond Yield "Conundrum" from a Macro-Finance Perspective

In 2004 and 2005, long-term interest rates remained remarkably low despite improving economic conditions and rising short- term interest rates, a situation that then-Federal Reserve Board Chairman Alan Greenspan dubbed a "conundrum." We document the extent and timing of this conundrum using two empirical no-arbitrage macro-finance models of the term structure of interest rates. These models confirm that the recent behavior of long-term yields has been unusual-that is, it cannot be explained within the framework of the models. Therefore, we consider other macroeconomic factors omitted from the models and find that some of these variables, particularly declines in long-term bond volatility, may explain a portion of the conundrum. Foreign official purchases of U.S. Treasuries appear to have played little or no role.Term structure; Term premium; Bond pricing; Affine no-arbitrage model

The bond yield "conundrum" from a macro-finance perspective

In 2004 and 2005, long-term interest rates remained remarkably low despite improving economic conditions and rising short-term interest rates, a situation that former Fed Chairman Alan Greenspan dubbed a "conundrum." We document the extent and timing of this conundrum using two empirical no-arbitrage macro-finance models of the term structure of interest rates. These models confirm that the recent behavior of long-term yields has been unusual--that is, it cannot be explained within the framework of the models. Therefore, we consider other macroeconomic factors omitted from the models and find that some of these variables, particularly declines in long-term bond volatility, may explain a portion of the conundrum. Foreign official purchases of U.S Treasuries appear to have played little or no role.Monetary policy - United States ; Federal funds rate ; Treasury bonds