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A Model of Target Changes and the Term Structure of Interest Rates

Pierluigi Balduzzi, Giuseppe Bertola and Silverio Foresi

No 4347, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We explore the effects of official targeting policy on the term-structure of nominal interest rates, adapting relevant insights from theoretical work on "peso problems" to account for realistic infrequency of target changes. Our analysis of daily U.S. interest rates and newly available historical targets provides an interpretation for persistent spreads between short-term money-market rates and overnight fed-funds targets, and for the poor performance of expectations-hypothesis tests: it is the policy-induced component of fed funds dynamics that appears to be erroneously anticipated by the market. Still, allowance for serial correlation in target changes makes it possible to extract from interest-rate data an expected-knoll series which is quite consistent with the assumptions of the model, indicating that some features of the interest-rate-targeting process are incorporated by market expectations.

JEL-codes: E43 E44 (search for similar items in EconPapers)
Date: 1993-04
Note: ME AP
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Published as Balduzzi, Pierluigi, Giuseppe Bertola and Silvero Foresi. "A Model Of Target Changes And The Term Structure Of Interest Rates," Journal of Monetary Economics, 1997, v39(2,Jul), 223-249.

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