Monetary Policy Expectation Errors

73 Pages Posted: 8 Apr 2020 Last revised: 13 Apr 2021

See all articles by Maik Schmeling

Maik Schmeling

Goethe University Frankfurt - Department of Finance; Centre for Economic Policy Research (CEPR)

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department; CREATES - Aarhus University

Sigurd Steffensen

Danmarks Nationalbank (central bank of Denmark)

Date Written: March 12, 2020

Abstract

We use survey expectations about future monetary policy to decompose excess returns on fed funds futures and overnight index swaps into a term premium and an expectation error component. We find that excess returns are primarily driven by expectation errors, while term premia are economically small and negative on average. Most expectation errors stem from market participants underestimating how aggressively the Federal Reserve has eased policy during the last three decades. Our findings reveal that market participants are continuously learning about the central bank's reaction function and have been slow to recognize the rising importance attributed to deteriorating financial conditions and falling stock prices. We document similar results in an international sample of six major currency areas.

Keywords: Fed funds futures, overnight index swaps, forecast evaluation, expectation formation, monetary policy

JEL Classification: E43, E44, G12, G15

Suggested Citation

Schmeling, Maik and Schrimpf, Andreas and Schrimpf, Andreas and Steffensen, Sigurd, Monetary Policy Expectation Errors (March 12, 2020). Available at SSRN: https://ssrn.com/abstract=3553496 or http://dx.doi.org/10.2139/ssrn.3553496

Maik Schmeling (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://sites.google.com/site/maikschmeling/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

CREATES - Aarhus University ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Sigurd Steffensen

Danmarks Nationalbank (central bank of Denmark) ( email )

Havnegade 5
Copenhagen, 1093
Denmark

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