Interest Rate Targeting and the Dynamics of Short-Term Rates
NBER Working Paper No. 5944
We find that in 1989-1996, when U.S. monetary policy tightly targeted overnight fed funds rates, the volatility and persistence of spreads between target and term fed funds levels were larger for longer-maturity loans. We show that such patterns are consistent with an expectational model where target revisions are infrequent and predictable. In our model, the (autoco-) variance of the spreads of term fed funds rates from the target increases with maturity because longer-term rates are more heavily influenced by persistent expectations of future target changes.
Published: Journal of Money Credit and Banking, Vol. 30, issue 1 (February 1998) pp. 26-50