The Response of Market Interest Rates to Discount Rate Changes

By Dueker, Michael J. | Federal Reserve Bank of St. Louis Review, July-August 1992 | Go to article overview

The Response of Market Interest Rates to Discount Rate Changes


Dueker, Michael J., Federal Reserve Bank of St. Louis Review


IT IS WELL-ESTABLISHED that discount rate changes of the same size can have markedly different effects on market interest rates. Studies of such effects, starting with Thornton (1982), have generally divided discount rate changes into two groups: "technical" changes, those made solely to keep the discount rate in line with market rates, and other "non-technical" changes.(1) The former generally do not have a significant impact on market rates, while the latter generally do. The use of this technical/non-technical dichotomy is predicated on the assumption that the market responds to a discount rate change based on the reasons for the change. Hakkio and Pearce (1992) find that the reasons generally fall into three categories: "(1) conditions in the market for bank reserves ...; (2) movements in intermediate targets such as the money supply and the foreign exchange value of the dollar; and (3) movements in ultimate targets such as inflation and economic growth." They observe that "changes in the rate because of type (1) factors are likely to be used to complement open market operations, while changes because of type (2) or (3) factors are more likely to be used as signals of future Fed policy."(2) Thus, technical changes result when the opportunity cost to banks of borrowing reserves--the federal funds rate less the discount rate--is too high or low to be consistent with attaining the Fed's operating target. Since October 1982 that target has been the level of borrowed reserves.(3) Non-technical changes, on the other hand, encompass all of the other reasons the Fed might change the discount rate. Clearly a combination of the factors identified by Hakkio and Pearce can be behind a given discount rate change, so the reaction of market interest rates to discount rate changes might be more heterogeneous than the technical/non-technical dichotomy would suggest. Moreover, as the efficient markets hypothesis implies, the response of market interest rates to a discount rate change should vary with the amount of new information the discount change imparts regarding the Fed's policy intentions or the state of the economy in general.(4)

This article presents results on the differential response of market interest rates to discount rate changes using an econometric framework that explains more heterogeneous responses in market interest rates than the technical/non-technical dichotomy allows. The mixture model employed here assumes that the market response is determined by either a "high-response" or "low-response" data-generating process. Inferences about which process governs a given period's interest rate depend on the information policymakers cite when they change the discount rate. Thus, we can consider hypotheses like "the higher the unemployment rate, the larger the response of market interest rates to a discount rate change of a given size." With the technical/non-technical dichotomy, in contrast, a discount rate change is described as non-technical if the Fed mentions any number of things in its announcement, such as the inflation rate, unemployment rate, industrial production, money growth rate, etc. The technical/non-technical dichotomy tells us little about the relative importance of these individual factors. A principal aim of the mixture model employed here is to study the influence these individual factors have on the market response.

This paper also includes some conjectural interpretations of the empirical results. For example, if the market rates respond strongly to discount rate changes when the unemployment rate is high, one might conclude that the market believes that the Fed will consistently change monetary policy in reaction to shifts in the unemployment rate. Objectively, however, the mixture model's fit and forecasts of the interest rate response serve as measures of its performance relative to the standard technical/non-technical dichotomy. The second half of the paper addresses the implication of the efficient markets hypothesis that a discount rate change must be "news" for market rates to respond by testing whether the timing of discount rate changes is sufficiently predictable to require that models of the market's response to discount rate changes distinguish explicitly between anticipated and unanticipated changes. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

The Response of Market Interest Rates to Discount Rate Changes
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.