The Pavlovian Response of Term Rates to Fed Announcements

Selva Demiralp and Oscar Jorda

Department of Economics from California Davis - Department of Economics

Abstract: The traditional view of the monetary transmission mechanism rests on the

premise that the Federal Reserve (Fed) controls the level of the Federal

funds rate via open market operations and the liquidity effect. By contrast,

this paper argues that the Fed also manipulates the Federal funds rate via

public disclosures of the new level of the Federal funds rate target and the "announcement effect.'' We define the announcement effect as the portion of

interest rate movements associated with public statements on interest rate targets that do not require conventional open market operations for their support. This paper provides evidence on how the Fed uses the liquidity effect in conjunction with the announcement effect to execute monetary policy. In addition, it investigates the implications of the

announcement effect on term structure behavior and the rational expectations

hypothesis.

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Related works:
Working Paper: The Pavlovian Response of Term Rates to Fed Announcements (2003)
Working Paper: The Pavlovian response of term rates to Fed announcements (2001)
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