Economics at your fingertips  

Expectations and the monetary policy transmission mechanism

Gordon H. Sellon

Economic Review, 2004, issue Q IV, No v.89, no.4, 5-41

Abstract: In principle, the monetary policy transmission mechanism can be described rather simply. When the Federal Reserve raises its target for the federal funds rate, other interest rates also rise—reducing interest-sensitive spending and slowing the economy. Conversely, when the federal funds rate target is lowered, other interest rates tend to fall—stimulating spending and spurring economic activity. While adequate for some purposes, this stylized description of the transmission mechanism is less helpful in explaining the complex relationship between interest rates and monetary policy that is actually observed in financial markets. It also provides little insight into the source of the Federal Reserve’s leverage over market interest rates. Indeed, how does control over a relatively insignificant interest rate—the overnight federal funds rate—allow the Federal Reserve to influence the whole spectrum of short-term and long-term market rates? Sellon describes a simple analytical framework that provides a better conceptual understanding of the monetary policy transmission mechanism and also helps explain the complex relationships between monetary policy and interest rates observed in financial markets. In this framework, financial market expectations about future monetary policy play a central role. Indeed, expectations about the path of future policy actions are the driving force in determining market interest rates. Consequently, understanding how financial markets construct this expected policy path and what factors cause the path to change is critical to understanding the transmission process and the behavior of interest rates. This framework also highlights the important role central bank communications play in the transmission mechanism and the evolution of market interest rates.

Keywords: Monetary policy; Interest rates; Transmission mechanism (Monetary policy) (search for similar items in EconPapers)
Date: 2004
References: Add references at CitEc
Citations: View citations in EconPapers (5) Track citations by RSS feed

Downloads: (external link) (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Ordering information: This journal article can be ordered from

Access Statistics for this article

More articles in Economic Review from Federal Reserve Bank of Kansas City One Memorial Drive, Kansas City, MO 64198. Contact information at EDIRC.
Bibliographic data for series maintained by LDayrit ().

Page updated 2019-06-26
Handle: RePEc:fip:fedker:y:2004:i:qiv:p:5-41:n:v.89no.4