The Identification Of The Response Of Interest Rates To Monetary Policy Actions Using Market-based Measures Of Monetary Policy Shocks

It is common practice to estimate the response of asset prices to monetary policy actions using market-based measures of monetary policy shocks, such as the federal funds futures rate. The author shows that because interest rates and market-based measures of monetary policy shocks respond simultaneously to all news and not simply news about monetary policy actions, market-based measures of monetary policy shocks yield biased estimates of the response of interest rates to monetary policy actions. The author proposes a methodology that corrects for this "Joint-response bias." The results indicate that the response of Treasury yields to monetary policy actions is considerably weaker than previously estimated.