The Dynamic Relationship between the Federal Funds Rate and the Treasury Bill Rate: An Empirical Investigation

37 Pages Posted: 14 Mar 2002

See all articles by Daniel L. Thornton

Daniel L. Thornton

Federal Reserve Bank of St. Louis - Research Division

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Date Written: February 2002

Abstract

This article examines the dynamic relationship between two key US money market interest rates - the federal funds rate and the 3-month Treasury bill rate. Using daily data over the period from 1974-99, we find a long-run relationship between these two rates that is remarkably stable across monetary policy regimes of interest rate and monetary aggregate targeting. Employing a non-linear asymmetric vector equilibrium correction model, which is novel in this context, we find that most of the adjustment toward the long run equilibrium occurs through the federal funds rate. In turn, there is strong evidence for the existence of significant asymmetries and non-linearities in interest rate dynamics that have implications for the conventional view of interest rate behaviour.

Keywords: Interest rates, term structure, equilibrium correction, non-linear dynamics

JEL Classification: E43

Suggested Citation

Thornton, Daniel L. and Sarno, Lucio, The Dynamic Relationship between the Federal Funds Rate and the Treasury Bill Rate: An Empirical Investigation (February 2002). CEPR Discussion Paper No. 3225. Available at SSRN: https://ssrn.com/abstract=303982

Daniel L. Thornton

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8582 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://research.stlouisfed.org/econ/thornton/

Lucio Sarno (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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