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RWP 22-02, February 2022

This paper studies the transmission of Federal Reserve communication to financial markets and the economy using new measures of the term structure of policy rate uncertainty. Movements in the term structure of interest rate uncertainty around FOMC announcements cannot be summarized by a single measure but instead are two dimensional. We characterize these two dimensions as the level and slope factors of the term structure of interest rate uncertainty. These two monetary policy uncertainty factors significantly help to explain changes in Treasury yields and forward real interest rates around FOMC announcements, even after accounting for changes in the expected path of policy rates. Moreover, we demonstrate that focusing on just a single dimension of monetary policy uncertainty provides an inaccurate description of how policy uncertainty shapes the transmission of FOMC announcements. Finally, our policy uncertainty factors provide stronger first-stage instruments in a proxy SVAR setting which implies more expansionary macroeconomic effects of forward guidance than those estimated only using the expected path of policy rates.

JEL Classifications: E32, E52

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Article Citation

  • Bundick, Brent, Trenton Herriford, and A. Lee Smith. 2022. "The Term Structure of Monetary Policy Uncertainty." Federal Reserve Bank of Kansas City, Research Working Paper no. 22-02, February. Available at External Linkhttps://doi.org/10.18651/RWP2022-02

Authors

Brent Bundick

Sr. Research and Policy Advisor

Brent Bundick is a Senior Research and Policy Advisor in the Economic Research Department of the Federal Reserve Bank of Kansas City. He rejoined the Department in 2014 after com…

A. Lee Smith

Vice President and Economist

Andrew Lee Smith is a Vice President and Economist in the Economic Research Department of the Federal Reserve Bank of Kansas City. Prior to joining the department in 2014, Mr. Sm…