The Effects of Monetary Policy Surprises on Asset Prices

A study published in the Federal Reserve Bank of St. Louis Review examined how unexpected changes to the Federal Open Market Committee’s (FOMC’s) federal funds target and postmeeting statements strongly and consistently affected asset prices, including interest rates, exchange rates and (for target changes) stock prices.

In their study, Christopher Neely, assistant vice president and economist with the St. Louis Fed, and Brett Fawley, formerly of the St. Louis Fed, looked at the joint evolution of Federal Reserve policy and the study of the impact of monetary policy surprises on high-frequency asset prices. They reviewed existing literature of studies of these impacts and noted, “A key lesson from this literature is that researchers must properly account for Federal Reserve procedures to draw the correct inference about the impact of monetary surprises. Specifically, the increasing transparency of Fed procedures and objectives, coupled with credibility won over several decades, has enabled the FOMC to influence asset prices with statements rather than large and disruptive surprises in overnight interest rates.”

Neely and Fawley pointed to a 1989 paper as evidence that a lack of clarity may have played a role in FOMC decisions affecting asset prices: “The fact that Cook and Hahn were able to link federal funds target changes—not just surprises—in the 1970s to asset price changes suggests that the Fed’s lack of clarity produced such poor expectations of funds target changes that such changes were largely unexpected, nearly equivalent to surprises.”

The increasing transparency was aided by procedural changes from the FOMC, such as a series of changes in the FOMC’s communication policy over the time period 1993-1995:

• March 1993: Merged FOMC “Minutes of Actions” and “Policy Record” into one new document labeled the “Minutes of the FOMC”
• February 1994: Included first postmeeting statement with a qualitative description of change in policy
• August 1994: Included some reasoning behind decisions in its statement
• July 1995: Included an actual numerical federal funds target in its statement

Neely and Fawley wrote, “These changes reduced the necessity of accounting for other news that might affect asset prices and the simultaneity of monetary policy and asset price changes. In addition, the resultant increased Fed transparency has greatly improved the market’s ability to forecast and price in monetary policy actions well before they happen.”

• Review: The Evolution of Federal Reserve Policy and the Impact of Monetary Policy Surprises on Asset Prices
• On the Economy: Inflation and the Role of Fed Credibility
• On the Economy: 38^th Fall Conference Volume Now Available