Always and Everywhere Inflation? Treasuries Variance. Decomposition and the Impact of Monetary Policy

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1 Always ad Eveywhee Iflato? Teasues Vaace Decomposto ad the Impact of Moetay Polcy Aleados Kotokas, Chales Nola ad Zvle Zekate Adam Smth Busess School Uvesty of Glasgow Septembe 2015 Abstact Ths pape vestgates the souces of vaato Teasuy bods etus ad the ole of moetay polcy ove the last thee decades. At the fst stage of ou aalyss, we decompose uepected ecess etus o 2-, 5- ad 10-yea Teasuy bods thee compoets elated to evsos epectatos (ews) about futue ecess etus, flato ad eal teest ates. Ou esults dcate that flato ews s the key dve of Teasuy bod etus. At the secod stage, we evaluate the mpact of covetoal ad ucovetoal moetay polcy o Teasuy bod etus ad the compoets. We fd that the postve mpact of moetay polcy easg o Teasuy bod etus s lagely eplaed though dowwad evsos flato epectatos. Keywods: Bod Maket Vaace Decomposto; Moetay Polcy; Facal Css. JEL classfcato: G12; G01; E44; E52. Coespodg autho. Adam Smth Busess School, Accoutg ad Face Subject aea, Uvesty of Glasgow, Glasgow, G12 8QQ, UK, aleados.kotokas@glasgow.ac.uk, Tel. +44 (0) Adam Smth Busess School, Ecoomcs Subject Aea, Uvesty of Glasgow, Glasgow, G12 8QQ, UK, chales.ola@glasgow.ac.uk, Tel. +44 (0) Tel. +44 (0) Adam Smth Busess School, Ecoomcs Subject Aea, Uvesty of Glasgow, Glasgow, G12 8QQ, UK, z.zekate.1@eseach.gla.ac.uk, Tel. +44 (0) We would lke to thak C. Busde, C. Faveo, C. Floacks, A. Kostaks, cofeece patcpats at the 2015 SIRE Asset Pcg Cofeece ad the 4th UECE Cofeece o Ecoomc ad Facal Adjustmets fo useful commets ad suggestos. We would also lke to thak Tom Doa fo helpful advce o the estmato code. 1

2 1. Itoducto The geatest pat of the thee-decade log bull-u Teasues took place wth a evomet of low ad stable flato ad sustaed ecoomc gowth. Statg fom the md-1980s, the macoecoomc taqullty that defed the Geat Modeato ea was accompaed by some ague delveed by a appaetly smple ad pedctable ule udelyg the coduct of moetay polcy, based upo tagetg of the Fed Fuds ate (FFR). That ea of stablty ad pedctablty came to a abupt ed wth the global facal css of As the zeo lowe boud o teest ates costaed polcymakes the US ad elsewhee, covetoal moetay polcy was uable to boost ecoomc actvty. The Fed adopted o-covetoal polcy tools, cludg lqudty facltes ad outght puchases of Teasuy bods ad othe assets fom the pvate secto, ode to mpove facal maket codtos ad educe loge-tem teest ates. Afte almost s yeas of upecedeted epaso the Fed s balace sheet, the ed of quattatve easg (QE) was aouced Octobe 2014 asg questos about the pospects of Teasues the cotet of the Fed s et pla. Udestadg how Teasues espod to moetay actos s cucal fo polcy makes ad vestos at a global level gve the US dolla s eseve cuecy status. Ths study coducts a empcal vestgato of the souces of vaato Teasuy bod etus ad the ole of moetay polcy ove the last thee decades, theeby estg upo two mpotat stads of the bod maket lteatue. The fst stad cludes studes that assess the ole of macoecoomc foces, most mpotatly flato, detemg bod maket volatlty. As Duffee (2014) otes, the sgfcace of flato sk fo omal bods wth pomet tem stuctue models vaes cosdeably fom vey hgh (Pazzes ad Schede; 2007) to almost zeo (Cheov ad Muelle; 2012). Dffeet estctos o sk pema dyamcs may play a ole eplag these dffeeces. A alteatve appoach to coduct the assessmet, ot elyg upo stog theoetcal assumptos, uses dettes lkg uepected ecess bod etus to evsos epectatos ( ews ) about futue ecess etus, flato ad eal teest ates. News ae detfed usg a VAR tme-sees ecoometc model. The decomposto of etus to ews tems was poeeed bod maket studes by Campbell ad Amme (1993) who bult upo Campbell ad Shlle s (1988) ad Campbell s (1991) eale wok. Usg ths appoach, t s commoly foud that evsos flato epectatos accout fo most of the shocks to log-tem govemet bod etus the US (Campbell ad Amme, 1993; Egsted ad Taggaad, 2007) ad othe coutes (Ba ad Pesaa, 1997; Ceedese ad Malluc, 2015). 2

3 The secod stad of the lteatue cosdes the bod maket effects of moetay polcy actos. Two key fdgs fom eale studes, coducted po to the facal css, ae that Teasues sgfcatly espod to shfts the FFR ad the espose teds to dmsh at loge matutes (Kutte, 2001; Gukayak, Sack, ad Swaso, 2005; Cochae ad Pazzes, 2002). Followg the oset of the facal css, the mplemetato of QE led to a suge of studes that eame ts mpact o the bod maket. Usg vaous appoaches, t s commoly foud that QE was effectve educg log-tem Teasuy bod yelds. As to how ths was acheved, the estg lteatue emphaszes two potetal chaels. Accodg to the sgallg chael, QE povded fomato to maket patcpats about the commtmet of the Fed to ease moetay polcy, leadg to lowe epectatos of futue shot-tem ates. Ths developmet eplas, though the epectatos theoy of the tem stuctue, the educto log-tem yelds. O the othe had, the potfolo balace chael assumes mpefect substtutablty of bods wth dffeet matutes, cosstet wth pefeed habtat vestos (Vayaos ad Vla, 2009). Accodg to t, the QE-duced decle the supply of log-tem bods educed the yeld by compessg the tem pemum. The empcal evdece s athe med. Fo eample, Gago et al. (2011) ad D'Amco et al. (2012) fd that eductos the yeld of log-tem Teasues pmaly eflect a lowe tem pemum, whle the esults of Chstese ad Rudebusch (2012) ad Baue ad Rudebusch (2013) favou the sgallg chael. The med empcal evdece togethe wth the empcal falue of the epectatos theoy (Thoto, 2005; Sao, Thoto ad Valete, 2007) ad the stog theoetcal assumptos udelyg pefeed habtat (Thoto, 2012) mply that ou udestadg of how QE led to lowe bod yelds s stll complete. I ths we pape we take a alteatve oute to detfy the souces of the bod maket s espose to moetay polcy. To do so, we modfy Beake ad Kutte s (2005) eteso of Campbell ad Amme s (1993) famewok so that t s applcable to bod maket etus. 1 At the fst stage of ou aalyss, we decompose uepected ecess etus o 2-, 5- ad 10-yea Teasuy bods to ews about futue ecess etus, flato ad eal teest ates. At the secod stage, we evaluate the mpact of covetoal ad ucovetoal moetay polcy shfts o Teasuy bod etus ad the compoets. The sample peod, , commeces dug the Geat Modeato ad eds the aftemath of the ecet 1 Usg the VAR-based decomposto of etus to ews compoets, Beake ad Kutte (2005) ad Mao (2014) eame the US stock maket s eacto to moetay polcy shfts. Bed, Hyde ad O Relly (2010) employ ths appoach to eame the pe-css ( ) domestc ad teatoal bod maket mpact of domestc moetay polcy actos the US, UK ad Gemay. I the case of the US, they do ot fd sgfcat effects. 3

4 facal css. We use FFR-based measues to captue covetoal polcy shfts, whle ocovetoal polces ae captued usg chages the moetay base. The use of quattybased dcatos s motvated by a umbe of ecet studes that evaluate the ole of the moetay base, o the supply eseves, as a alteatve opeatg taget fo moetay polcy (Cuda ad Woodfod, 2011; Getle ad Kaad, 2013). Thus, we cotbute to the estg lteatue thee mpotat ways. Fst, by usg a appoach that allows us to epla the bod maket eacto to moetay polcy shfts ove the last thee decades o the bass of ews about maco-fudametals ad sk. Secod, by payg specal atteto to the ole of the facal css ad the o-covetoal polces subsequetly adopted by the Fed. Thd, by cosdeg shote matutes, addto to the ofte aalysed 10-yea Teasuy bod, ode to eame whethe the effects vay acoss the yeld cuve. Pevewg ou empcal esults, the ma fdgs ca be summazed as follows. Fst, acoss dffeet matutes, vaace decomposto esults show that ews about futue flato s the key facto eplag the vaablty of uepected ecess Teasuy bod etus dug the ea of lowe flato that commeced the md-1980s. O the othe had, the fluece of sk pemum ews ad eal teest ews s typcally eglgble. Secod, egadg the effect of moetay polcy actos, we fd that moetay easg s assocated wth hghe uepected ecess Teasuy bod etus, wth the mpact beg geeally stoge at loge matutes. I the case of quatty-based moetay polcy dcatos, the bod maket effects lagely eflect developmets that occued at the peak of the facal css autum At the tme, the upecedeted epaso the Fed s balace sheet was accompaed by a stoge bod maket espose to moey gowth. Thd, ou esults hghlght the mpotace of flato ews eplag the bod maket eacto to moetay polcy. We fd that the postve effect of moetay easg o uepected ecess Teasuy bod etus maly comes fom a coespodg egatve effect o flato epectatos. The dowwad adjustmet flato epectatos s cosstet wth the moetay polcy sgallg agumet of Rome ad Rome (2000) the cotet of whch maket patcpats espod to sgals povded by the actos of the Fed. Fouth, the evdece s oveall ot suppotve fo the potfolo balace mechasm s pedcto of a stog ole fo sk pemum ews eplag the bod maket eacto to the epadg balace sheet of the Fed. These fdgs ae obust to vaous obustess checks, elated to the specfcato of the udelyg VAR ad the moetay polcy poes. 4

5 The est of the pape s stuctued as follows. Secto 2 pesets the methodology. The dataset s descbed Secto 3. Secto 4 cotas the empcal esults fom the basele aalyss, whle Secto 5 cotas the obustess checks. Secto 6 cocludes. 2. Methodology 2.1 Ecess bod etus decomposto Usg the famewok of Campbell ad Amme (1993), we decompose cuet peod uepected ecess bod etus to evsos epectatos about futue oe-peod ecess bod etus (), flato (π) ad eal teest ates ( ): E E 1 1 1, t1 ( t1 t ) j, t1 j t 1 j t1 j, t1, t1, t1 j1 j1 j1 (1) E whee, t1, t1 t, t1 epesets the uepected oe-peod log etu o a -peod zeo-coupo bod ecess of the cotuously compouded oe-peod omal teest ate, t, deotes evsos epectatos egadg futue ecess bod etus (sk 1 pemum ews),, t epesets evsos epectatos about futue flato (flato 1 ews) ad, t deotes evsos epectatos egadg futue eal teest ates (eal 1 teest ate ews). 2 The decomposto mples that postve uepected ecess bod etus must be assocated wth deceases epected futue ecess etus dug the lfe of the bod, deceases epected futue flato ates, deceases epected futue eal teest ates, o a combato of the thee. Equato (1) s a dyamc accoutg detty that ases fom the defto of bod etus ad mposes teal cosstecy o epectatos. 3 It s ot a behavoual model cotag ecoomc theoy ad asset pcg assumptos. Nevetheless, both the Fshe hypothess ad the epectatos theoy of the tem stuctue have mpotat mplcatos fo the decomposto of ecess bod etus. Specfcally, the fome hypothess mples that e ate eal teest ates ae costat ad theefoe the eal teest ate ews tem s zeo. The latte hypothess assumes tme-vaat epected ecess bod 2 See Apped A fo the devato. 3 Note that the case of zeo-coupo bods the dyamc accoutg detty holds eactly. 5

6 etus whch ae cosstet wth the sk pemum ews tem beg zeo. Theefoe, the eteme, f both hypotheses hold, flato ews wll be the oly souce of vaato bod etus ecess of the shot-tem sk-fee ate. 4 Fom Equato (1) t follows that the total vaace of ecess etus ca be decomposed to the sum of the thee vaaces plus the espectve covaace tems:, t1, t1, t1, 1 2, 1, t t, t1, t1, 1 t, t1, t1 Va Va Va Va Cov 2 Cov, 2 Cov, (2) I ode to evaluate the elatve mpotace of ews about sk pemum, flato ad eal teest ates, we omalse each of the vaace ad covaace tems Equato (2) by the total vaablty of ecess etus. The delta method s used to calculate the stadad eos fo the tems of the vaace decomposto sce these ae olea fuctos of the estmated VAR paametes Vecto autoegessve model ad ews The mplemetato of the vaace decomposto fo ecess bod etus eques empcal poes fo the o-dectly obsevable evsos epectatos egadg futue ecess etus, flato ad eal teest ates. Campbell ad Amme s (1993) methodology lks these multpeod epectatos to the statoay dyamcs of a vecto autoegessve model. Specfcally, a fst-ode VAR s employed, volvg the vaables of teest alog wth othe dcatos that may be useful foecastg them, to obta empcal poes fo the ews compoets Equato (1). 6 The foecast eos ad the estmated paametes fom the VAR model ae used to costuct tme sees of evsos epectatos fo the vaables of teest. The statg pot s the defto of a state vecto cotag statoay vaables that help to measue o foecast ecess bod etus, flato ad eal teest ates: 4 Estg evdece egadg the empcal valdty of the epectatos hypothess ad the Fshe hypothess ca be descbed as med wth the ole of the adopted testg pocedues beg cucal. Sao, Thoto ad Valete (2007) use a moe poweful test wth ethe macoecoomc factos o moe tha two bod yelds ad ovetu evdece fom covetoal tests by showg that the epectatos hypothess ca be ejected thoughout the matuty spectum. Chstopoulos ad Leo-Ledesma (2007) attbute the lack of wdespead empcal evdece fo the Fshe hypothess cotegato-based studes to o-leates the log-u elatoshp betwee omal teest ates ad flato. 5 Ths appoach s also employed by Campbell ad Amme (1993), Ba ad Pesaa (1997) ad Beake ad Kutte (2005). 6 The VAR(1) assumpto s ot estctve. I the obustess aalyss secto we show that the fdgs that we obta usg the VAR(1) model ae obust to the use of hghe ode VARs. 6

7 Z AZ W (3) t1 t t1 Whee Z t s a vecto of edogeous state vaables cluded the model, A deotes a mat of VAR paametes, ad W t s a vecto of foecast esduals. The state vecto cludes the chage the omal shot-tem sk-fee ate, y 1,t ; the spead betwee log-tem ad shot-tem yelds, s,t ; the eal teest ate, t ; the elatve bll ate, b t,.e. the dffeece betwee the omal shot-tem teest ate ad ts 12-moth backwads movg aveage. The fst two vaables the state vecto ae used to costuct ovatos ecess bod etus. The tem spead has stog pedctve powe ove bod etus (Campbell ad Shlle, 1991; Fama ad Blss, 1987; Geewood ad Vayaos, 2014), whle the elatve bll ate s a foecastg vaable that ca captue loge-u dyamcs of teest ate chages wthout toducg log lags (Campbell ad Amme, 1993; Ba ad Pesaa, 1997; Beake ad Kutte, 2005). The VAR estmates allow us to compute uepected ecess bod etus ad the thee compoets detfed Equato (1) as follows: ( 1)( s W s W ), (4) T T, t1 1 t1 2 t1 T 1 s, 1 3( I A) ( A A ) W t t1, (5) 1 1 s I A I I A A A W 1 T, t1 1 t1, t1, (6). (7), t 1, t 1, t1, t 1 whee s T s a ut vecto wth epesetg th equato the model ad accodgly the th elemet of a vecto s set to 1; I s the detty mat. 7 Equato (4) shows that cuet uepected ecess bod etus ae obtaed usg ovatos the chage of the omal shot-tem ate ad the tem spead. The cluso of the eal teest ate the state vecto allows the etacto of ews about t dectly fom the model as dcated by Equato (5). I Equato (6), the flato ews tem s computed by combg ovatos the chage of the omal shot-tem ate wth ews about eal teest ates. Fally, Equato (7) shows that sk pemum ews s obtaed as a esdual usg the dyamc accoutg detty ad the estmates of the othe compoets. Backg 7 See Apped B fo moe detals. 7

8 out sk pemum ews as a esdual s ecessay fo zeo-coupo bods sce shkg matuty ove the lfe of a bod pecludes the dect foecastg of ecess etus usg the VAR model. Hece, ecess bod etus ae ot dectly cluded the VAR ad the elated ews compoet s backed out as a esdual tem. As Egsted, Pedese ad Taggaad (2012) epla, the eed to accout fo shkg matutes s cucal wth ths famewok. Igog ths may lead to uwaated coclusos about the elablty of the bod maket vaace decomposto, as Che ad Zhao (2009). 8 The VAR model that s used to etact ews s assumed to cota all elevat fomato that vestos may have whe fomg epectatos about the futue. Gve vaablty the compoets of ecess bod etus, the vaace decomposto s deed codtoal upo ths fomato. If vestos have addtoal fomato that s ot peset the state vecto, the elatve mpotace of the esdual compoet (sk pemum ews ou aalyss) may be ovestated. 9 I the obustess aalyss secto we show that ou basele fdgs, based o the state vecto descbed above, ae obust to the copoato of addtoal maco-facal pedcto vaables the state vecto. 2.3 Moetay polcy effects The above sectos epla how the vaato of the uepected ecess bod etus ca be lked to ews about futue ecess etus, flato ad eal teest ates, ad how these ews tems ca be obtaed fom a VAR model. I ths secto we peset the famewok that we use to estmate the mpact of moetay polcy actos o the bod maket. To do so, we modfy Beake ad Kutte s (2005) eteso of Campbell ad Amme s (1993) methodology fo the case of the bod maket. 10 Ou appoach geeates estmates of 8 Che ad Zhao (2009) decompose uepected ecess bod etus two compoets: cash flow ews ad sk pemum ews, whee the fome s backed out as a esdual fom the VAR estmato. Sce omal cash flows of Teasuy bods ae fed, the estmated cash flows ews must oly be eflectg modellg ose, whle eal teest o flato shocks wll be copoated dscout ate ews. They fd, howeve, that the estmated vaace of cash flows ews s ot zeo, o eve smalle tha that of dscout ate ews, ad attbute ths to mssg state vaables the dscout ate foecast. Howeve, as Egsted, Pedese ad Taggaad (2012) pot out, Che ad Zhao (2009) eglect the shkg matuty of the bods ove the lfetme. Futhemoe, whle they use ecess bod etus the VAR, the fomula that they use fo the decomposto holds fo aw etus oly. 9 Campbell ad Amme (1993) pot out that the sg of the possble bas s uceta sce t wll deped o the covaaces betwee state vaables ad ay omtted vaables. 10 Bed, Hyde ad O Relly (2010) also cosde the mpact of moetay polcy actos o bod etus ad the compoets usg Beake ad Kutte s (2005) VAR-based appoach. The aalytcal famewok, howeve, s dffeet fom ous sce the fomulas that they use fo the decompostos of bod etus apply to the case of fte matuty coupo bods. Moeove, they clude ecess etus dectly the VAR ad back out flato ews as a esdual tem. 8

9 the mpact of moetay polcy actos o uepected ecess bod etus ad the elated ews tems, theeby povdg sghts to souces of the bod maket s espose to moetay polcy. The statg pot s the cluso of a moetay polcy dcato () as a eogeous vaable the VAR model: Z AZ W (8) * t1 t t1 t1 whee s a vecto that cludes the state vaables espose paametes to cotempoaeous moetay polcy actos. As we epla Secto 3.3, we employ fou alteatve moetay polcy dcatos that elate to actual ad supse chages the polcy ate ad the quatty of moey. The ogal VAR eo vecto Wt 1 Equato (3) s decomposed a compoet elated to the moetay polcy actos, t 1, ad a compoet elated to othe fomato, W. We poceed by estmatg the ogal VAR model to obta estmates of A ad the * t 1 egess the foecast esduals vecto o the moetay polcy dcato vaable ode to estmate. The moetay polcy effect o the cuet uepected ecess etus ad ews about eal teest ates, flato ad the sk pemum ca be computed usg Equatos (9)- (12), espectvely: 11, 1 ( 1)( T T t s 1 s2 ) (9) T 1 s, 1 3 ( I A) ( A A ) (10) t 1 1 T 1, 1 3 ( ) ( ) T 1 1 t s I A A A s I A I I A A A (11) (12), t1, t1, t1, t1 Thus, the espose of ecess bod etus ad the compoets to moetay polcy actos depeds both o ad the dyamcs of the VAR though A. As Beake ad Kute (2005), the delta method s used to compute stadad eos fo these esposes. 11 * To obta Equatos (9)-(11), W t+1 s eplaced wth t 1 W Equatos (4)-(6) ad the patal t1 devatves wth espect to t+1 ae take. 9

10 3. Data ad vaables 3.1 Sample peod We use mothly data ove the peod 1985:1 2014:2. Ou sample commeces dug the ealy yeas of the Geat Modeato peod, whle ts latte pat cotas the ecet global facal css ad ts aftemath. Ou estmatos ae coducted ove both the full sample peod (1985:1 2014:2) ad a shote sample (1985:1 2007:7) that eds po to the oset of the ecet facal css. 12 Dog so, we get sghts about the mpact of css o the vaace decomposto of uepected ecess bod etus ad the elatoshp betwee moetay polcy actos ad bod etus. 3.2 VAR state vaables We use the 1-moth Teasuy bll ate, obtaed fom the Cete fo Reseach Secuty Pces (CRSP), as a poy fo the omal shot-tem sk-fee teest ate (y 1,t ). The log-shot spead (s,t ) s calculated as the dffeece betwee 10-, 5-, ad 2- yea zeocoupo Teasuy bod yelds ad y 1,t. Data o cotuously compouded zeo-coupo yelds s obtaed fom the daly dataset povded by Gukayak, Sack, ad Wght (2007). 13 The e post eal teest ate s defed as the dffeece betwee y 1,t-1 ad the cuet mothly flato ate, measued by the chage the log of the seasoally adjusted CPI All tems de. CPI data s povded by the Fedeal Reseve Bak of St Lous (FREDII database). The elatve bll ate s the devato of y 1,t fom ts 12-moth backwads movg aveage. All state vaables ae demeaed po to estmatos ad epessed pecetages pe aum o cotuously compouded bass (ed of moth data used). 3.3 Moetay polcy dcatos Both the Fed s opeatg pocedues ad the udelyg maco-facal evomet have chaged ove tme. By the ealy 1980s, Volcke s dsflato was lagely accomplshed wth flato shaply educed to aoud 3% at Ths developmet allowed teest ates to decle ad evetually usheed the Geat Modeato ea that was chaactesed by oveall 12 The stat of the facal css s dated to August 2007 whe majo doubts about global facal stablty emeged ad the fst majo cetal bak tevetos espose to ceasg tebak maket pessues took place (Buemee, 2009; Kotokas, MacDoald ad Saggu, 2013). 13 The dataset s avalable ole at 10

11 macoecoomc stablty. Moetay polcy coduct dug that peod was chaactesed by FFR tagetg ad ceasg taspaecy, wth the Fed aoucg the decso fo the taget FFR afte each FOMC meetg sce Febuay The facal css of bought ths beg egme to a ed ad had a sgfcat mpact o the Fed s appoach to moetay polcy mplemetato. The Fed espoded aggessvely to the css by educg the taget FFR to ea zeo. Moeove, t used vaous tools (lqudty facltes ad asset puchases) to mpove facal maket codtos ad put dowwad pessue o loge-tem teest ates, theeby suppotg ecoomc actvty. 15 Coductg the LSAPs pogamme, the Fed puchased sgfcat amouts of logetem assets fom the pvate secto, maly Teasuy bods ad agecy motgage backed secutes (MBS), leadg to sgfcat chages the sze ad composto of ts balace sheet. 16 The cease the Fed s assets was matched by a epaso ts labltes. Patculaly, eseve balaces have ceased cosdeably elatve to the level po to the facal css ad ae hghly ecess of the egulatoy equemets. Reseves became the ma compoet of the moetay base sce cuecy cotued to ehbt a oly gadual cease ove tme. Fgue 1 shows the damatc se total eseves ad the moetay base sce late 2008 ad also hghlghts that, cotast to aow moey, boad moey (M2) dd ot sgfcatly epad. The lack of a damatc shft boade moetay aggegates s elated to the fact that baks let the levels of ecess eseves to cease shaply (Fawley ad Neely, 2013). Fama (2013) attbutes ths developmet to the paymet of teest o ecess eseves by the Fed sce Octobe 2008 whch mples that they o loge mpose a cost o baks. These developmets eewed the focus of cetal bakes ad moetay ecoomsts to quatty-based polcy dcatos wth a umbe of ecet theoetcal (Cuda 14 US moetay polcy opeatg pocedues have cluded peods of tagetg the FFR,.e. the teest ate o oveght loas of eseves betwee baks, ( ad 1988 peset), o-boowed eseves tagetg ( ) ad boowed eseves tagetg ( ). Thee s substatal empcal evdece dcatg that the FFR s the key US moetay polcy dcato dug both the pe-1979 ad post-1982 peods (Beake ad Blde, 1992; Beake ad Mhov, 1998; Rome ad Rome, 2004). 15 These cluded () the povso of shot-tem tem lqudty to baks ad othe facal sttutos though dscout wdow ledg ad othe facltes, such as the Tem Aucto Faclty; () the dect povso of lqudty to boowes ad vestos mpotat cedt makets va e.g. the Commecal Pape Fudg Faclty; () the Lage Scale Asset Puchases pogamme that amed to suppot cedt makets ad mpove oveall facal codtos. See Table C2 Apped C fo a lst of the elevat aoucemets by the Fed. 16 Fgue C2 Apped C shows developmets the Fed s holdgs of Teasuy secutes acoss dffeet matutes. Holdgs of shot-u Teasues have decled due to the tal stelsato of lqudty opeatos ad the Opeato Twst (OT) that followed late o. Meawhle, loge-u secutes held outght have sgfcatly ceased eflectg chages the atue ad scope of the Fed s Ope Maket Opeatos (OMOs) as a esult of the LSAPs. Tadtoally, OMOs volved the epuchase (epo) ad sale-epuchase (evese epo) of secutes, maly shot-u Teasues, by the Fed ode to keep the FFR close to the taget. Fama s (2013) empcal evdece dcates that deed the FFR adjusts quckly towads the taget. 11

12 ad Woodfod, 2011; Getle ad Kaad, 2013) ad empcal studes (Gambacota, Hofma ad Peesma, 2014) vestgatg the macoecoomc ole of LSAPs ad evaluatg the moetay base, o the supply of eseves, as a alteatve opeatg taget. [FIGURE 1 HERE] I ou empcal aalyss we use fou moetay polcy dcatos that ae elated to actual ad uepected chages the FFR ad the (log) moetay base. Iteest ate-based measues ae captug covetoal moetay polcy, whle o-covetoal polcy dmesos ae captued by quatty-based measues. The fst dcato s the chage the FFR, FFR t = FFR t FFR t-1, a poy fequetly utlsed pevous studes (Che, 2007; Kotokas ad Kostaks, 2013; Mao, 2014). The secod dcato solates supse FFR chages usg data fom FFR futues ad the methodology of Kutte (2001). Pevous studes that employ ths poy clude Beake ad Kutte (2005) ad Bed, Hyde ad O Relly (2010). The moth-t uepected FFR chage, FFR U t, ca be calculated as follows: U 1 D 1 t t, d t1, D D d 1 FFR f (13) whee t,d deotes the taget FFR o a day d of moth t, ad f s the ate coespodg to 1 t 1, D the 1-moth futues cotact o the last (D th ) day of moth t-1. The defto s based o that the FFR futues cotact s settlemet pce s detemed by the mothly aveage FFR. 17 The thd dcato s the gowth ate of aow moey, measued by the chage the log of the seasoally adjusted (St. Lous adjusted) moetay base (MB), MB t = MB t MB t-1. A umbe of studes that focus o the Japaese QE epeece use developmets aow moey as poy fo o-covetoal moetay polcy (Kmua et al., 2003; Haada ad Masujma, 2009). Developmets the moetay base should be moe fomatve, as compaed to asset-sde measues, about the Fed s o-covetoal polces. Ths s because asset-sde poes just eflect LSAPs ad show sgfcat actvty oly sce ealy 2009, whle moetay base chages futhe captue the mpact of the vaous o-stelsed lqudty facltes of the Fed that wee heavly used autum Ideed, the hghest moetay base gowth ates US ecod occued Octobe ad Novembe 2008 eachg 20% ad 26% pe moth, espectvely FFR data s obtaed fom the FREDII database, whle Bloombeg s the souce of FFR futues data. It should be oted that measug supse chages usg the aveage FFR may udestate the magtude of polcy supses. The tme-aggegato ssue s aalysed Evas ad Kutte (1998). 18 The coespodg fgues fo total eseves gowth wee 78% ad 66%. They also costtute hstocal hghs. 12

13 The fouth dcato s based upo pevous wok by Cove (1992) ad Kaas (2013) ad obtas supses aow moey gowth, MB t U, as the esduals fom a egesso of moetay base gowth o ts ow lags ad lags of uemploymet: MB a MB UN t j tj t t j1 1 m (14) whee UN t = log[u t /(1 U t )] ad U t deotes uemploymet. 19 Fgue 2 plots all fou moetay polcy dcatos. Towads the ed of 2008, quatty-based poes become hghly actve whle the volatlty of teest-ate based poes des out sce the zeo lowe boud was eached. [FIGURE 2 HERE] Ou methodology assumes eogeety fo the moetay polcy dcatos. Ths assumpto would ot hold f moetay polcy ad the bod maket would jotly ad cotempoaeously espod to ew ecoomc fomato. I ode to eame whethe ou polcy dcatos eact to such ews, we egess them o vaables that captue supses ofam payolls, dustal poducto gowth, etal sales gowth, coe ad headle CPI flato. We do ot fd a sgfcat cotempoaeous moetay polcy espose to macoecoomc supses. 20 The eogeety assumpto would also fal the pesece of a cotempoaeous Fed espose to developmets the maket fo Teasues. Nevetheless, empcal evdece o whethe the Fed s systematcally followg Teasues s oveall ococlusve ad athe elusve whe medum ad loge tem yelds, as the data used ou study, ae eamed (Nmak, 2008; Vazquez, Maa-Doloes ad Lodoo, 2013). Hece, the eogeety assumpto should ot be too estctve. 4. Empcal fdgs 4.1 VAR estmato esults Table 1 epots the estmated VAR(1) coeffcets fo the full ad pe-css sample peods fo thee alteatve VAR models that oly dffe tems of the zeo-coupo bod 19 The umbe of lags (=m=7) s chose by the Akake fomato cteo. Least squaes estmates of Equato (14) dcate that moetay base gowth s maly eplaed by ts ow lags, wth the R 2 beg equal to 50%. I the obustess aalyss secto we epemet wth alteatve empcal specfcatos fo the moetay base gowth ad show that ou basele esults ae obust. 20 Due to data avalablty, the sample peod fo these egessos stats 1991:10. See Table C3 Apped C fo the esults. 13

14 yeld used to calculate the log-shot spead (10-, 5- ad 2-yea yelds). Heteoskedastcty ad autocoelato-cosstet stadad eos ae show paetheses. The esults ca be summased as follows. Fst, the oe-moth ahead foecastg powe of the VAR s qute easoable. The hghest R 2 values ae ecoded the spead ad elatve bll ate equatos, agg fom 52% to 81%, whle the R 2 fo the chage omal shot-tem ate ad eal teest ate equatos s betwee 20%-40%. Secod, the chage the omal shot-tem ate s pedcted by ts ow lag, the lagged log-shot spead ad the lagged elatve bll ate. The log-shot spead s hghly pesstet wth ts autoegessve coeffcet beg close to acoss the dffeet cases. I addto, the spead ca be foecasted by the lagged elatve bll ate, albet ot the case of 2-yea bods, ad the lagged chage the omal shot-tem ate. The eal teest ate typcally follows a AR(1) pocess wth a coeffcet of about 0.4 to 0.5. The lagged spead geeally helps to foecast the eal ate the case of 10- yea ad 5-yea bods. The elatve bll ate s foecast by ts ow lag, the lagged spead ad the lagged chage the omal shot-tem ate. Regadg the magtude, sg ad statstcal sgfcace of the estmated coeffcets, the fdgs Table 1 ae boadly le wth Campbell ad Amme (1993). Thd, thee ae o substatal chages the VAR estmates acoss the full ad pe-css samples. Ths dcates that the oe-peod dyamcs of the system ae ot sgfcatly affected by the facal css. Fouth, the estmated VARs ae dyamcally stable sce o oot les outsde the ut ccle. 21 [TABLE 1 HERE] 4.2 Vaace decomposto esults The vaace decomposto esults fo 10-, 5- ad 2-yea bods ae show Table 2. I addto to the vaaces ad covaaces of the thee compoets of uepected ecess bod etus, omalsed by the vaace of the etu ovato tself, we epot the R 2 statstcs fom uvaate egessos of uepected ecess etus o each of the estmated compoets. The key fdg Table 2 s that acoss dffeet matutes ews about futue flato s the domat facto eplag the vaato of Teasuy bod etus. Fo eample, the full sample vaace decomposto attbutes 83% of the vaace of 10-yea bod ecess etus ovatos to the vaace of flato ews. Both the volatlty of flato ews ad that of uepected ecess Teasuy bod etus decease as we move 21 Note also that Augmeted Dckey-Fulle ad Phllps Peo ut oot test esults dcate that all state vaables ae statoay (see Table C1-Pael B Apped C). 14

15 fom loge-tem to shote-tem bods, but the latte s decease s moe poouced. 22 Hece, the ato of the volatlty of flato ews to the volatlty of uepected ecess bod etus s hghe fo shote-tem bods. Whe we eclude the ecet facal css ad ts aftemath fom the sample that s used fo the VAR estmato, we obta vaace decompostos that ae smla to the full sample. Ths fdg s cosstet wth the fact that the VAR estmato esults Table 1 do ot dcate sgfcat chages acoss the two samples the pedctablty of the compoets of ecess bod etus. 23 The domat ole of flato s also hghlghted by the hgh R 2 values egessos of etus ovatos o flato ews. O the othe had, estmates of the sk pemum ad eal teest ate ews vaace tems ae typcally smalle magtude ad statstcally sgfcat, whle the covaaces also play a mo ole the decomposto. The mpotace of flato ews s cosstet wth pevous evdece fo the US ove sample peods that clude the hghly flatoay 1970s ad ealy 1980s (Campbell ad Amme, 1993, Egsted ad Taggaad, 2007; Bed, Hyde ad O Relly, 2010). 24 Thus, evsos flato epectatos mataed the domat fluece ove the Teasuy bod maket dug the ea of lowe flato that commeced the md-1980s. [TABLE 2 HERE] 4.3 Moetay polcy effects o uepected ecess etus ad the compoets Tables 3-6 epot estmates of the mpact of moetay polcy actos o uepected ecess Teasuy bod etus ad the compoets ove the full ad pe-css sample peods. 25 The esults Tables 3 ad 4 ae based o teest ate measues of moetay polcy (actual ad uepected chage the FFR, espectvely). The fst ma fdg fom teest ate measues s that moetay polcy actos sgfcatly affect the bod maket 22 The stadad devato of uepected ecess Teasuy bod etus decles fom 35.08, the case of 10- yea bods, to ad 6.69 fo 5- ad 2-yea bods, espectvely. The coespodg fgues fo flato ews ae 32.02, ad The R 2 statstcs fom the VAR model equatos fo the chage the omal shot-tem sk-fee ate ad the tem spead ema faly stable whe the facal css ad ts aftemath ae emoved fom the sample. 24 I le wth ou esults, Duffee s (2014) fdgs usg the Campbell ad Amme (1993) appoach also hghlght the sgfcat ole of flato ews fo the vaace decomposto of 10-yea bods ove a sample peod that commeces dug the Geat Modeato ad eds afte the facal css ( ). 25 Note that the VAR model that geeates ecess bod etus ovatos ad the assocated ews compoets s estmated ove the full sample peod. The use of a loge sample should mpove the pecso of the estmates. Nevetheless, we have also epemeted by estmatg pe-css moetay polcy actos egessos usg etus ovatos ad ews compoets etacted fom a VAR model estmated wth pe-css data. Dog so, we fd smla esults to those epoted Tables 3-6. These esults ae avalable upo equest. 15

16 acoss all thee matutes ad acoss both sample peods. Moetay easg (FFR cuts) s assocated wth hghe cotempoaeous uepected ecess etus. The secod ma esult s that the effect of moetay polcy actos o the bod maket s lagely eplaed though the flato ews chael. Specfcally, we fd that the key dve of the postve bod etus espose to FFR cuts s the egatve effect o flato epectatos. Aothe mpotat featue of ou esults s the tedecy of the FFR mpact o bod etus ad the ma compoet, flato ews, to cease magtude, albet ot mootocally, as the matuty ceases. Whle eductos the FFR eet a lage ad statstcally sgfcat effect o flato epectatos, the mpact o epected ecess bod etus (tem pemum) s typcally smalle o sgfcat. I the case of 10-yea bods the sk pemum ews espose s sgfcat at the 5% level but the sg that t ehbts s dffeet acoss the two teest ate measues that we use. Usg actual FFR chages, the postve effect of moetay easg o epected ecess etus s outweghed by the egatve effect o flato epectatos, so that the total effect o bod etus s postve. 26 Fally, the espose of evsos eal teest ate epectatos to FFR chages s almost always statstcally sgfcat. [TABLES 3-6 HERE] Tables 5 ad 6 use polcy dcatos that ae elated to the (log) moetay base (actual ad uepected chage, espectvely). We focus o the full sample estmato esults sce the pe-css sample ecludes the ecet facal css ad ts aftemath, that s, the peod whe quatty-based dcatos became stogly actve due to the o-covetoal polces that wee adopted by the Fed. The ma sghts that we detfed usg teest ate-based measues ema oveall vald full sample estmatos wth quatty-based measues. Patculaly, the postve effect of moetay easg (hghe moetay base gowth) o uepected ecess Teasuy bod etus comes though dowwad evsos flato epectatos, wth the mpact beg geeally stoge at loge matutes. The full sample esults dcate that moey gowth sgfcatly affects eal teest ate epectatos, wheeas the mpact o sk pemum ews teds to be statstcally sgfcat oly whe we use actual chages the (log) moetay base. The postve effect of moetay easg o 26 Re-aagg the dyamc detty show Equato (12), we ca see that the total moetay polcy effect o uepected ecess bod etus must equal the egatve sum of the effects o flato, eal teest ate ad sk pemum ews. 16

17 epected ecess etus ad eal teest ates s compesated by the egatve mpact o flato epectatos. [FIGURES 3, 4 HERE] Compag the full sample wth the pe-css esults fom quatty-based measues of moetay polcy, t becomes appaet that the fome lagely eflect developmets that occued dug the facal css. Followg the collapse of Lehma Bothes Septembe 2008, flato epectatos shaply deteoated le wth the woseg ecoomc outlook (Campbell, Shlle ad Vcea, 2009). 27 At the same tme, the Fed sgfcatly epaded the pace of moetay easg, both the covetoal ad o-covetoal sese. The FFR decled by 160 bass pots betwee Septembe-Novembe 2008 ad the moetay base gowth ate ecoded hstocal hghs due to the heavy usage of o-stelsed Fed lqudty facltes. Fgues 3 ad 4, whch plot ecusve estmates of the mpact of actual ad uepected (log) moetay base chages o uepected ecess Teasuy bod etus ad flato ews, also suggest that a mpotat stuctual shft took place autum Followg the upecedeted epaso the moetay base ad the aoucemet of QE1, the elatoshp betwee moey gowth ad bod etus teds to cease magtude, whle the mpact o flato epectatos becomes stogly egatve. The espose paametes ehbt a tedecy to become smalle sze afte the tal shock, suggestg that futhe ouds of QE may ot have bee as fluetal as the fst oe. Summasg ou ma esults, we fd that the postve effect of moetay easg o the Teasuy bod maket s maly the cosequece of dowwad adjustmets flato epectatos. I le wth ths eplaato, facal maket patcpats ofte tepet epasoay polcy as a sgal of woseg ecoomc outlook, weake flato ad theeby good ews fo Teasues. 28 All the moe so, whe moetay easg takes place dug peods of facal tumol sce t may efoce flght to safety tadg ad theefoe cease the pce of Teasues (Kotokas, MacDoald ad Saggu). 29 I ageemet wth the 27 By the autum of 2008, flato became stogly egatve ecodg a sample mmum of -1.8% (moth-o moth) Novembe The omal shot-tem teest ate fell to almost zeo, theeby pushg up the e post eal teest ate to hghly postve values. 28 See, fo eample, the followg ecept fom the Facal Tmes (2/2/2001): Govemet bod pces ose yesteday as makets aoud the wold dgested Wedesday s 50 bass pots teest ate cut by the US Fedeal Reseve. slowe gowth ad less flato was good fo the bod maket Kotokas, MacDoald ad Saggu (2013) use a evet study famewok ad fd that dug the ecet facal css, FFR cuts wee assocated wth decles stock pces. They ague the hstocally low teest ates that matealsed dcated to vestos that ecoomc codtos wee shaply deteoatg ad poftablty would be lowe fo some tme, tggeg a ebalacg of potfolos towads less sky assets. Flght to safety has bee well-studed the pevous lteatue, wth a umbe of studes focusg o stock-bod 17

18 flato ews chael tepetato, Rome ad Rome (2000) fd that moetay polcy actos sgal mpotat addtoal fomato that Fed possess about flato, elated to the supeo esouces that t commts to foecastg. 30 Wth ths famewok, epasve polcy eveals a Fed foecast of lowe flato. Maket patcpats espod to these sgals by evsg the flato epectatos dowwads leadg to lowe yelds ad hghe etus fo bods. Ou esults ae oveall ot suppotve of the potfolo balace mechasm, accodg to whch moetay easg, va a epadg Fed balace sheet, should cease cuet peod bod etus pmaly though dowwad adjustmets epected ecess etus (tem pema). I cotast to pevous evdece fom sgle equato evet-studes (Kutte, 2001; Gukayak, Sack, ad Swaso, 2005) ad VAR studes (Evas ad Mashall, 1998; Beumet ad Foye, 2009), we fd that the moetay polcy mpact o the bod maket does ot decle as we move fom shote to loge matutes but athe teds to become stoge. Thee ae vaous possble eplaatos fo the sgfcat eacto at the log-ed of the bod maket. Accodg to Rome ad Rome (2000), the effects fom asymmetc fomato egadg flato ad the elated moetay polcy sgallg ae lage eough to epla the stog espose of log-tem teest ates to polcy actos. Iflato sluggshess, leadg to pesstet effects eal teest ates, asymmetc fomato about the equlbum eal ate, ad ove-eacto of log-tem ates to chages shot ates povde alteatve mechasms that ca epla the mpact of moetay polcy thoughout the tem stuctue (Rome ad Rome, 2000). Rolley ad Sello (1995) pot out that f polcy actos ae see as elatvely pemaet o as the fst a sees of futue actos, the espose of log-tem ates may be lage tha the espose of shot-tem ates. Fally, Ag et al. (2011) emphasse the ole of shfts the Fed s polcy eacto fucto. They fd that log-tem bods ae sestve to flato polcy shfts wth ceases the Fed s esposveess to flato ceasg both shot-tem ates ad the tem spead. 31 maket lqudty lkages ad the ole of moetay polcy (Choda, Saka ad Subahmayam, 2005; Goyeko ad Ukhov, 2009). 30 The dea that that Fed may have access to pvate fomato about shocks to output ad pces s also cetal the theoetcal model of Ellgse ad Södestöm (2001). 31 The tuto s that vestos peceve a hghe polcy loadg to flato at the shot-ed of the yeld cuve as a facto that ceases the eposue of bods to flato sk acoss all matutes. 18

19 5. Robustess checks We eame the obustess of ou fdgs a umbe of ways ad fd that the empcal fdgs epoted Secto 4 ae oveall ot sestve to these chages. Fst, we use alteatve state vecto specfcatos fo the udelyg VAR model. Secod, we cosde hghe-ode VARs. Thd, we modfy the model that s used to etact moetay base gowth supses. Fally, we cosde alteatve quatty-based moetay polcy dcatos. 5.1 Alteatve state vecto specfcatos The bechmak VAR state vecto cludes the chage the omal shot-tem skfee ate, the tem spead, the eal teest ate, ad the elatve bll ate. I addto to teest ate vaables, some studes fd that macoecoomc factos ad facal codtos dcatos ad ae helpful pedctg bod etus (Ag ad Pazzes, 2003; Ludvgso ad Ng, 2009; Fcke ad Mekhoff, 2014). Motvated by ths evdece, we eame whethe ou basele fdgs ae obust to copoatg measues of maco-facal codtos the VAR state vecto. The followg vaables ae cosdeed: dustal poducto gowth ate, uemploymet, the Chcago Fed Natoal Actvty Ide (CFNAI), ad the Chcago Fed Adjusted Natoal Facal Codtos Ide (ANFCI). CFNAI s a measue of oveall ecoomc actvty, calculated as the weghted aveage of 85 mothly dcatos of atoal ecoomc actvty. ANFCI solates the compoet of facal codtos ( moey makets, debt ad equty makets, ad the tadtoal ad shadow bakg systems) that s ucoelated wth ecoomc codtos. The vaace decomposto esults that we obta usg the alteatve state vectos ae show show Tables C4-C7 Apped C, whle the coespodg moetay polcy effects egessos ae peseted Tables C8-C23. Oveall, as the case of the bechmak state vecto vaace decomposto, flato ews s the majo compoet of uepected ecess Teasuy bod etus. Futhemoe, as the basele esults, the postve effect of moetay easg o bod etus comes fom a coespodg egatve effect o flato epectatos. Thus, accoutg fo addtoal foecastg vaables does ot alte the coclusos fom the basele aalyss. 19

20 5.2 Hghe ode VARs The bechmak VAR model s fst-ode VAR. I ode to eame whethe a moe comple dyamc stuctue affects the basele esults, we cosde hghe ode VARs (Ba ad Pesaa, 1997; Mao, 2014). The vaace decomposto ad moetay polcy effects esults Tables C24 ad C25-C28, espectvely, Apped C ae based upo a thd-ode VAR model. They dcate that the ma coclusos about the ole of flato ews the vaace decomposto, as well as the elatoshp betwee bod etus ad moetay polcy, ad ae ot affected by pasmoy the VAR ode. Smla sghts ae povded by VAR(2) ad VAR(6) models. These esults ae avalable upo equest. 5.3 Alteatve models fo moetay base gowth supses The moetay base gowth supses that we use the basele aalyss ae obtaed as esduals fom a egesso of moetay base gowth o ts ow lags ad lags of uemploymet. Followg pevous wok by Cove (1992), we model moetay base gowth usg two addtoal specfcatos fo the set of eplaatoy vaables. Specfcally, lags of moetay base gowth ae complemeted wth ethe lags of dustal poducto gowth, o lags of dustal poducto gowth ad lags of the fst dffeece of the 3-mothTeasuy bll ate. Estmates of moetay polcy effects usg these alteatve measues of moetay base gowth supses ae peseted Tables C29 ad C30 Apped C. They ae oveall smla to the bechmak esults. The postve bod maket espose to moetay easg s maly eplaed by dowwad evsos flato epectatos. 5.4 Alteatve quatty-based moetay polcy dcato The lage cease total eseves, commecg at the ed of 2008, made them the domat compoet of the moetay base. Motvated by ths developmet, we cosde two addtoal quatty-based measues of moetay polcy: actual ad uepected chages (log) total eseves. As wth moetay base gowth supses, the latte ae obtaed as esduals fom a egesso of total eseves gowth o the ow lags ad lags of uemploymet. The esults fom moetay polcy egessos wth total eseves as a quatty-based dcato ae show Tables C31 ad C32 Apped C. The ma coclusos fom the basele aalyss ema vald sce moetay polcy shfts have a 20

21 sgfcat effect o bod maket pefomace ad flato ews s typcally the ma compoet of bod etus that s affected. 6. Coclusos Followg the ecet facal css ad the actos take by the Fed, aalyses of the souces of vaato the bod maket ad the ole of moetay polcy came to the focus of academcs, vestos ad polcymakes. Ths pape eteds the aalyss of Campbell ad Amme (1993) to vestgate the souces of vaato Teasuy bod etus acoss dffeet matutes. Ths famewok combes a dyamc accoutg detty wth a VAR tme-sees ecoometc model to decompose uepected ecess bod etus to evsos epectatos (ews) about futue ecess etus, flato ad eal teest ates. Futhemoe, we modfy Beake ad Kutte s (2005) eteso of Campbell ad Amme s famewok to obta sghts to the souces of the bod maket s espose to moetay polcy. Usg ths appoach, we estmate the mpact of actual ad uepected chages moetay polcy dcatos o bod etus ad the compoets. We use FFR-based dcatos to captue covetoal moetay polcy, wheeas shfts the moetay base ae employed to captue the o-covetoal dmesos of moetay polcy dug the css ad ts aftemath. The vaace decomposto esults show that ews about futue flato costtute the lagest compoet of uepected ecess Teasuy bod etus, whle the cotbuto of sk pemum ews ad eal teest ate ews s typcally eglgble. Hece, we cofm ad update pevous empcal evdece about the mpotace of flato ews fo loge-tem bods by showg that they mataed the domat fluece dug the ea of lowe flato that commeced the md-1980s. Moeove, we complete the pctue by povdg ew evdece whch shows that flato ews also domate the vaace decomposto of medum- ad shote-tem bods. Wth espect to the mpact of moetay polcy actos, the esults dcate that moetay easg s assocated wth hghe bod etus, wth the mpact beg geeally stoge at loge matutes. I the case of quatty-based moetay polcy dcatos, the bod maket espose lagely eflects developmets that occued at the peak of the facal css autum As to why the bod maket espods ths mae, the esults hghlght the ole of flato ews. We fd that the postve effect of moetay easg o bod etus maly comes fom a coespodg egatve effect o flato epectatos. 21

22 Ths evdece s le wth the agumet of Rome ad Rome (2000) about moetay polcy actos actg as sgals of addtoal fomato o flato that Fed possesses, to whch maket patcpats espod. O the othe had, evdece favou of the potfolo balace mechasm s pedcto of a stog ole fo sk pemum ews wth the cotet of a epadg Fed balace sheet s athe elusve. 22

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