Deck 7: Inflation, Monetary Policy, and the Federal Funds Rate

Question 1

What is missing from the expectations hypothesis?

Answer 1

The expectations hypothesis assumes that future rates are known and, therefore, not random. This means that there is no uncertainty about these rates. This is false, future interest rates are uncertain. Yet the principal problem is that by being uncertain and affecting the value of market participants' securities they are also a source of risk that is priced in the securities. Thus the expectations hypothesis isn't an adequate way of explaining interest rates.

Question 2

What is the Fed's mandate?

Answer 2

Promote employment, stable in?ation and low long term interest rates.

Question 3

Can nominal interest rates or real interest rates be negative? Why? Why not?

Answer 3

Negative interest rates can only occur in real variables. This is because real rates are the rate of an investment net of inflation. If inflation is high, then real interest rates will be negative. Nominal interest rates cannot be negative.

Question 4

Assume that you believe that the Fed funds rate is best explained by the following: You also ?nd that standard error equals 0.33, and that r0 =6%.

Question 5

If market participants don't expect yield to go up a year from now, can the yield curve be upwards sloping? Why?

Question 6

Through Open Market Operations, how do you raise rates?

Question 7

Interpret the following regression explaining the Fed rate:
Answer the following:
i. What is the interpretation of ?? Does this make any economic sense?
ii. How well do past rates explain present rates?
iii. How well does Payroll growth explain Fed fund rates?
iv. How well does in?ation explain Fed fund rates?
v. Is this model better than the one presented previously?

Question 8

What is the expectations hypothesis?

Question 9

Which are the main tools that the Federal Reserve have to conduct Mon- etary Policy?

Question 10

How does inflation affect bonds?

Question 11

How does the Fed reach its desired target rate?

Question 12

Is using Fed funds futures to forecast the Fed rate unbiased?

Question 13

What is a TIPS?

Question 14

Through Open Market Operations, how do you lower rates?

Question 15

In what sense are bonds insurance against inflation? When does this not hold?