Do Short-Term Interest Rate Expectations Respond to New Information on Monetary Growth?

In recent years the importance of the role of the money stock has been increasingly emphasized in analysis and in FED policy making. During the 1970's the FED has established money stocK targets and has sought to make the money supply conform to those targets. In addition to concerns as to whether the targets of the FED are appropriate or not, professional and public concern has been expressed about the relative successfulness of the FED in achieving short-run and long-run targets. It has been suggested that money market reactions to the success or lack of success of the FED in achieving its targets influence interest rates. The FED has often warned that short-term variations in the money stock and failures to achieve the monthly tolerance ranges for the money stock may have no significance and that speculation based on such data is inappropriate. Nevertheless, the notion that movements in interest rates may reflect expectations about the future course of money stock and the perceived targets of the FED appears to have achieved some acceptance and is worth empirical investigation [17]. If expectations about the course of the money supply and surprises due to the actual unfolding path of the money supply produce changes in interest rate expectations that alter current interest rates, there may result changes in real economic variables [15]. This paper will specify and test the hypothesis that revisions in interest rates forecasts are systematically related to the market's forecast of monetary growth and subsequent unanticipated growth of the money stock. Section I posits a simple model of the structure of interest rates through which changes in interest rate expectations can be modeled.