Monetary Policy Regimes, Expected Inflation, and the Response of Interest Rates to Money Announcements

This paper examines the response of the term structure of interest rates to weekly money announcements. Estimated responses for both the pre- and post-October 1979 periods are first presented. Then, two competing hypotheses involving the policy anticipations and expected inflation effects are formally specified and compared to the estimated responses.Both hypotheses are found to be consistent with the responses, but they have sharply different implications about the Federal Reserve's short-run monetary policy. The expected inflation hypothesis implies that weekly money surprises should have persistent effects on the level of the money stock, reflecting shifts in the Federal Reserve's long-run target. In contrast, the policy anticipations hypothesis implies that the effectof money surprises should diminish over time, reflecting the Federal Reserve's desire to offset deviations from target. Additional empirical results reported in the paper support this latter description of the money stock process.