Academic journal article Contemporary Economic Policy

Effects on Interest Rates of Immediately Releasing FOMC Directives

Academic journal article Contemporary Economic Policy

Effects on Interest Rates of Immediately Releasing FOMC Directives

Article excerpt

I. INTRODUCTION

Each meeting of the Federal Open Market Committee (FOMC) generally focuses on short-run operations that are consistent with long-run objectives such as price stability. When the FOMC reaches a consensus about the general stance of short-term policy, it transmits a Domestic Policy Directive to the Manager of the Trading Desk at the Federal Reserve Bank of New York, providing the Trading Desk with guidance for the conduct of open market operations during the intermeeting period. Unlike changes in other components of monetary policy, however, the contents of a directive are not officially divulged to the public until approximately 45 days after an FOMC meeting.

This practice was broken on February 4, 1994 when, in the midst of a two-day meeting, the FOMC announced that it had decided to "increase slightly the degree of pressure on reserve positions . . . [an action] expected to be associated with a small increase in short-term money market rates" (see Board of Governors, 1994). This announcement and releases of FOMC directives on the day of the three subsequent FOMC meetings represented a wholesale change in the FOMC's attitude toward precommitment and the provision of information to financial markets. Until recently, and with the aid of a successful defense of an inquiry under the Freedom of Information Act (FOIA), the six week delay meant that the FOMC released one directive only after it had been supplanted by a new one. Thus, financial market participants always were unaware of the Fed's current policy stance--or, as some members of Congress have argued, sophisticated market participants were able to exploit this delay by discerning signals of policy changes that the average investor did not see.

These prompt announcements of directives also rebut key elements of the FOMC's defense in the 1976 FOIA filing. In that defense, the FOMC argued that such precommitment during the inter-meeting period would impair its ability to conduct monetary policy. The FOMC also argued that an "announcement effect" associated with immediate release of the directive would create additional volatility and uncertainty in financial markets. Indeed, the key element of its defense of the 1976 FOIA challenge was evidence that this increased volatility would raise the average level of interest rates by eight basis points and thereby increase the costs to the government of debt financing. However, this evidence was not based on any actual experience with early release of the directives.

This absence of market responses to directives released early may have ended in recent years. Periodic stories in the Wall Street Journal have reported the essence of 11 directives less than a week after the FOMC adopted them. Assuming that market participants viewed these stories as credible reports of FOMC decisions, one can employ "leaks" of the directives as empirical proxies for early releases. The analysis here uses these proxies to test whether advance news reports of the directive have engendered any unusual volatility in short-term financial markets. Moreover, in light of recent events, the analysis also focuses on recent Congressional hearings and the recent changes in FOMC practices.

II. THE ART OF "FEDSPEAK": THE DOMESTIC POLICY DIRECTIVE

The Domestic Policy Directive does not state policy actions in precise language but rather states them in "terms of art that have meaning when read by knowledgeable market participants" (emphasis added; see Axilrod, 1992). Indeed, Stern-light (1976, p. 6), a former manager of the Open Market Desk, writes, "It should be appreciated that full disclosure of the Directive is still not 'perfect information' as to precisely what the Open Market Desk will do--and indeed it is possible at times that disclosure of the Directive would be more misleading than no information at all." Many economists probably would disagree with this assertion, preferring instead Maisel's line of reasoning: "[most] experts on markets . …

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