Monetary policy surprises and interest rates: choosing between the inflation-revelation and excess sensitivity hypotheses.

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Monetary policy surprises and interest rates: choosing between the inflation-revelation and excess sensitivity hypotheses.

Romer and Romer (2000) reported that federal funds rate increases may raise expected inflation by revealing the Federal Reserve's private information about inflation. Gurkaynak, Sack, and Swanson (2005a) presented evidence that funds rate increases lowered long-term expected inflation. To choose between these hypotheses, we examine how monetary policy surprises affect daily traded commodity prices, term interest rates, and forward interest rates. We find that funds rate increases in the 1970s raised gold and silver prices and that increases after 1989 lowered gold and silver prices. We also find that funds rate hikes over both sample periods primarily affected short-term interest rates and near-term forward rates/For the 1970s, these results suggest that Romer and Romer's explanation is correct. For recent years, they indicate that funds rate increases affect real rates and may also be consistent with the findings of Gurkaynak, Sack, and Swanson.

JEL Classification: E43, E52

1. Introduction

Why do increases in the Federal Reserve's (Fed's) target for the federal funds rate raise interest rates on long-term Treasury securities? One might expect that contractionary monetary policy would raise short-term rates because of a liquidity effect and reduce long-term rates by lowering expected inflation. Yet Cook and Hahn (1989) reported that increases in the Fed's target for the federal funds rate from September 1974 to September 1979 raised interest rates at all horizons. Similarly, Kuttner (2001) found that unanticipated increases in the federal funds rate target over the Jun...

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