Let the Market Speak: Using Interest Rates to Identify the Fed Information Effect

I propose a novel method to identify the exogenous monetary shock from the signaling effect of a Fed announcements in real time. The method relies on the different ways monetary news and non-monetary news change the entire short end of the yield curve at high frequency, with the latter informed by market responses to macroeconomic data releases. The estimated revelation of Fed information is strongly correlated with the difference between market forecasts and the Fed’s own forecasts. The monetary shock is found to have a bigger effect on the economy than suggested using an instrument without adjustment for the signaling effect.

Download